-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WoWcKgEBa44Yb/rfUbUarhn++P6BjMiIq37UgUMHdT1yELmmJZMS4GjQPfU42vic RGkeQtsu7oDTp8ozcU+AuQ== 0000950130-97-001432.txt : 19970401 0000950130-97-001432.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950130-97-001432 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 17 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMBAC INC /DE/ CENTRAL INDEX KEY: 0000874501 STANDARD INDUSTRIAL CLASSIFICATION: SURETY INSURANCE [6351] IRS NUMBER: 133621676 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 001-10777 FILM NUMBER: 97570558 BUSINESS ADDRESS: STREET 1: ONE STATE ST PLZ CITY: NEW YORK STATE: NY ZIP: 10004 BUSINESS PHONE: 2126680340 MAIL ADDRESS: STREET 1: ONE STATE ST PLZ CITY: NEW YORK STATE: NY ZIP: 10004 10-K405 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER DECEMBER 31, 1996 1-10777 AMBAC INC. (Exact name of Registrant as specified in its charter) DELAWARE 13-3621676 (State of incorporation) (I.R.S. employer identification no.) ONE STATE STREET PLAZA NEW YORK, NEW YORK 10004 (Address of principal executive offices) (Zip code) (212) 668-0340 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: Title of each class Name of each exchange on which registered COMMON STOCK, $0.01 PER SHARE AND PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE, INC. SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the Registrant as of March 1, 1997 was $2,317,739,691 (based upon the closing price of the Registrant's shares of the New York Stock Exchange on March 1, 1997, which was $66.75). For purposes of this information, the outstanding shares of Common Stock which were owned by all directors and executive officers of the Registrant were deemed to be shares of Common Stock held by affiliates. As of March 1, 1997, 34,840,291 shares of Common Stock, par value $0.01 per share, (net of 499,901 TREASURY SHARES) AND 0 SHARES OF CLASS A COMMON STOCK, PAR VALUE $0.01 PER SHARE, WERE OUTSTANDING. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Annual Report to Stockholders for the year ended December 31, 1996 are incorporated by reference into Parts II and IV hereof. Portions of the Registrant's Proxy Statement dated March 31, 1997 in connection with the Annual Meeting of Stockholders to be held on May 14, 1997 are incorporated by reference into Part III hereof. TABLE OF CONTENTS PAGE ---- PART I Item 1. Business................................... 1 Item 2. Properties................................. 31 Item 3. Legal Proceedings.......................... 31 Item 4. Submission of Matters to a Vote of Security Holders................... 31 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..... 32 Item 6. Selected Financial Data.................... 32 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 32 Item 8. Financial Statements and Supplementary Data 33 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure....................... 33 PART III Item 10. Directors and Executive Officers of the Registrant.......................... 33 Item 11. Executive Compensation..................... 33 Item 12. Security Ownership of Certain Beneficial Owners and Management........... 33 Item 13. Certain Relationships and Related Transactions....................... 33 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......... 34 SIGNATURES............................................... 40 APPENDIX A Types and Ratings of Bonds................. A-1 FINANCIAL STATEMENT SCHEDULES............................ S-1 PART I ITEM 1. BUSINESS. GENERAL AMBAC Inc. (the "Company") is a holding company that provides through its affiliates financial guarantee insurance and financial services to clients in both the public and private sectors. The Company's principal operating subsidiary, AMBAC Indemnity Corporation ("AMBAC Indemnity"), is a leading insurer of municipal and structured finance obligations. The Company's Financial Services Division provides investment contracts, interest rate swaps and investment management and advisory services principally to states, municipalities, municipal authorities and hospitals and health organizations. During 1995 the Company sold its controlling position in its publicly traded health care information content subsidiary, HCIA Inc. ("HCIA"). In May 1996, the Company sold its remaining holdings in HCIA. During 1996 the Company acquired substantially all of the assets and the name of Cadre Financial Services, Inc. ("Cadre"). Cadre is a provider of cash management and investment advisory services to local school districts, hospitals and health organizations and municipalities. Also during 1996 the Company acquired a controlling interest in AMBAC Connect Inc. ("ACI"), the successor to Advanced Procurement Systems, Inc. ACI develops and markets software for governmental procurement applications. AMBAC Indemnity is primarily engaged in insuring municipal and structured finance obligations and is the successor of the oldest municipal bond insurance company, which wrote the first municipal bond insurance policy in 1971. Financial guarantee insurance written by AMBAC Indemnity in both the primary and secondary markets guarantees payment when due of the principal of and interest on the obligation insured. In the case of a default on the insured obligation, payments under the insurance policy may not be accelerated by the policyholder without AMBAC Indemnity's consent. AMBAC Indemnity seeks to maintain a diversified insurance portfolio which spreads its risk across a number of criteria, including issue size, type of bond, geographic area and issuer. As of December 31, 1996, AMBAC Indemnity's net insurance in force (after giving effect for reinsurance) was $227.2 billion. See "Insurance in Force" below. AMBAC Indemnity has been assigned triple-A claims-paying ability ratings, the highest ratings of Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Ratings Group ("S&P"), Fitch Investors Service, L.P. ("Fitch") and Nippon Investors Service, Inc. ("Nippon"). These ratings are an essential part of AMBAC Indemnity's ability to provide credit enhancement. See "Rating Agencies" below. The Company's municipal investment contract business ("MIC business") provides triple-A investment contracts primarily to states, municipalities and municipal authorities. The investment contracts are rated triple-A by virtue of AMBAC Indemnity's insurance policies which guarantee the MIC business' performance. Investment contracts are used by municipal bond issuers to invest bond proceeds until the proceeds can be used for their intended 1 purpose, such as financing construction. The municipal investment contract provides for the guaranteed return of principal invested, and for the payment of interest thereon at a guaranteed rate. See "Municipal Investment Contract Business" below. The Company provides interest rate swaps through its subsidiary AMBAC Financial Services, Limited Partnership ("AFS") to states, municipalities, municipal authorities and other entities in connection with their financings. The interest rate swaps provided by AFS are insured by triple-A rated AMBAC Indemnity and provide a financing alternative that can reduce a municipal issuer's overall borrowing costs. See "AMBAC Financial Services, Limited Partnership" below. As a holding company, AMBAC Inc. depends primarily on dividends from AMBAC Indemnity, its principal operating subsidiary, to pay dividends on its capital stock, to pay principal and interest on its indebtedness and to pay its operating expenses. Such dividends from AMBAC Indemnity are subject to certain insurance regulatory restrictions. See "Insurance Regulatory Matters -- Wisconsin Dividend Restrictions" below and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" in the Company's 1996 Annual Report to Stockholders. BUSINESS SEGMENTS The following paragraphs describe the business operations of AMBAC Inc., its subsidiaries and affiliates (sometimes collectively referred to as "the Company") for the Company's two business segments: Financial Guarantee Insurance and Financial Services. FINANCIAL GUARANTEE INSURANCE ----------------------------- Financial guarantee insurance of the type written by AMBAC Indemnity guarantees to the holder of the underlying obligation the timely payment of principal of and interest on such obligation in accordance with its original payment schedule. Accordingly, in the case of an issuer default on the insured obligation, payments under the insurance policy may not be accelerated by the policyholder without AMBAC Indemnity's consent. Financial guarantee insurance provides a form of credit enhancement which benefits both the issuer and the investor. Issuers benefit because their securities are sold with a higher credit rating than securities of the issuer sold on an uninsured basis, resulting in interest cost savings and greater marketability. In addition, for complex financings and obligations of issuers that are not well known by investors, insured obligations receive greater market acceptance than uninsured obligations. Investors benefit from greater marketability and a reduction in the risk of loss associated with an issuer's default. The Company derives financial guarantee insurance revenues from (i) premiums earned over the life of the obligations insured, (ii) net investment income, (iii) realized gains and losses and (iv) fees. Excluding transactions with affiliates, total financial guarantee insurance revenues were $266.3 million, $248.6 million and $225.0 million in 1996, 1995 and 1994, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 17 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. 2 Financial guarantee insurance is sold in two primary markets: the United States municipal market and the structured finance and asset-backed market. UNITED STATES MUNICIPAL MARKET Until 1993, AMBAC Indemnity was almost exclusively focused on the municipal market in the United States. The municipal market includes taxable and tax-exempt bonds, notes and other evidences of indebtedness issued by states, political subdivisions (e.g., cities, counties, towns and villages), water, sewer and other utility districts, higher educational institutions, hospitals, transportation and housing authorities and other similar authorities and agencies. Municipal obligations are supported by either the taxing authority of the issuer or the issuer's or underlying obligor's ability to collect fees or assessments for certain projects or public services. The following table sets forth the volume of new issues of long-term (longer than 12 months) municipal bonds and the volume of new issues of insured long-term municipal bonds over the period from 1987 through 1996 in the United States. NEW ISSUES OF U.S. LONG-TERM MUNICIPAL BONDS INSURED BONDS AS PERCENTAGE TOTAL INSURED OF TOTAL VOLUME VOLUME VOLUME ($ in Billions) ------- ------- -------- 1987...................... $105.0 $ 19.1 18.2 1988...................... 117.3 27.1 23.1 1989...................... 125.0 31.1 24.9 1990...................... 127.8 33.5 26.2 1991...................... 172.4 51.9 30.1 1992...................... 234.6 80.8 34.4 1993...................... 291.9 108.0 37.0 1994...................... 164.6 61.4 37.3 1995...................... 159.4 68.5 43.0 1996...................... 180.8 85.8 47.5 ______________ Source: Amounts in the total volume column (except for 1996) are based upon estimated data reported by The Bond Buyer's 1996 Yearbook. The 1996 volume amounts are AMBAC Indemnity estimates, compiled from industry sources including Securities Data Company, Inc. and The Bond Buyer. Statistics in the Insured Volume column include only the insured portion of an issue and are based upon industry sources including Securities Data Company, Inc. and The Bond Buyer. Amounts in the Total Volume and Insured Volume columns represent gross par amounts issued or insured, respectively, during such year. The foregoing table illustrates the changes in the total volume and insured volume of new issues of municipal bonds over the past ten years. The increase in volume of municipal bond issuance during 1991, 1992 and 1993 was primarily due to increased refunding activity related to a lower interest rate environment. The decrease in municipal bond issuance during 1994 and 1995 was primarily due to decreased refunding activity related to a higher interest rate environment. 3 Although there have been certain monetary defaults in bond issues of substantial amounts, incidents of monetary default on municipal bonds have been infrequent in recent years. With the exception of the default by the Washington Public Power Supply System, most monetary defaults since 1981 have been related to industrial revenue bonds, nursing home bonds, housing bonds and other non- general obligation bonds. Furthermore, based upon data reported by the Association of Financial Guaranty Insurers, the percentage of insured municipal bonds experiencing monetary defaults in recent years is relatively low compared to the entire municipal market. The relatively low incidence of municipal bond defaults may be partially the result of safeguards developed over the years since the Depression of the 1930's, when a great number of municipal defaults occurred. Such safeguards include the imposition of issuer debt limits, greater supervision by state governments of local debt administration, and more thorough credit reviews by investment firms, rating agencies and institutional investors. While these safeguards address many of the causes of earlier defaults, they may be inadequate to prevent an increased level of defaults in the future caused by presently unforeseen economic and other factors. For example, 1994 and 1995 were notable years in the municipal finance industry in that certain municipal issuers realized losses in their investment portfolios as a result of the use of derivative instruments. These investment losses, however, did not result in a higher level of ultimate payment defaults by municipal issuers. See "Losses and Reserves" below. STRUCTURED FINANCE AND ASSET-BACKED MARKET Insurance on securities in the structured finance and asset-backed market is typically issued in connection with structured financings or securitizations in which the securities being issued are secured by or payable from a specific pool of assets having an ascertainable cash flow or market value and held by a special purpose issuing entity. Such obligations include, but are not limited to: mortgage-backed securities and pools of home equity loans, credit card receivables, trade receivables or other assets. While most structured finance and asset-backed obligations are secured by or represent interest in pools of assets, monoline financial guarantors have also insured structured finance obligations secured by one or a few assets. In general, structured finance and asset-backed obligations are payable only from cash flow generated by a pool of assets and take the form of either "pass-through" obligations, which represent interests in the related assets, or "pay-through" obligations, which generally are debt obligations which are collateralized by the related assets. Both types of obligations also generally have the benefit of over-collateralization or one or more forms of credit enhancement to cover credit risks associated with the related assets. Structured finance and asset-backed obligations generally entail two forms of risks: asset risk, which relates to the amount and quality of asset coverage; and structural risk, which relates to the extent to which the transaction structure protects the interests of the investors, and therefore the insurer. In general, the amount and quality of asset coverage required is determined by the historical performance of the assets. The future performance of the underlying pool of assets will generally determine whether the amount of over-collateralization or other credit enhancement ultimately is sufficient to protect investors, and therefore the insurer, against 4 adverse asset performance. The ability of the servicer of the assets to properly service and collect the underlying assets often is a factor in determining future asset performance. Structural risks addressed by asset-backed transactions include bankruptcy and tax risks. Structured and asset-backed securities are usually designed to protect the investors, and therefore the insurer, from the bankruptcy or insolvency of the entity that originated the underlying assets as well as from the bankruptcy or insolvency of the servicer of those assets. (The servicer of the assets is typically responsible for collecting cash payments on the underlying assets and forwarding such payments, net of servicing fees, to the special purpose issuing entity). Related issues that often arise concern whether the sale of the assets by the originator to the issuer of the asset- backed obligations would be respected in the event of the bankruptcy or insolvency of the originator and whether the servicer of the assets may be permitted or required to delay the remittance to investors of any cash collections held by it at or received by it after the time it becomes subject to bankruptcy or insolvency proceedings. AMBAC Indemnity addresses these risks through its credit underwriting guidelines, standards and procedures. The structured finance and asset-backed market in which AMBAC Indemnity provides financial guarantee insurance is broad and disparate, comprising domestic (U.S.) and international transactions, and public issues and private placements. The varied classes of assets securitized or guaranteed, and the recent rapid development of the market make estimating the size of the aggregate structured finance and asset-backed markets difficult. One of the most well developed sectors of this market is the U.S. public asset-backed market. The volume in this market in recent years is summarized in the following table. NEW ISSUES OF U.S. PUBLIC ASSET-BACKED SECURITIES TOTAL VOLUME ($ in Billions) ------------ 1993................................................. $ 57.7 1994................................................. 75.5 1995................................................. 108.0 1996................................................. 150.5 _______________ Source: Amounts are based upon estimated data reported by Asset Sales Report. Just as the U.S. public asset-backed market has grown significantly in recent years, AMBAC Indemnity management believes the international markets for insured structured finance and asset-backed securities have also expanded. A number of important trends in international markets have contributed to this expansion. In the United Kingdom, Australia and elsewhere, ongoing privatization efforts have shifted the burden of funding from the government to public and private capital markets, where investors may seek the security of financial guarantee insurance. In Europe, there is growing interest in asset-backed securitization, especially through commercial paper conduits. 5 While the principles of securitization have been increasingly applied in overseas markets, development in particular countries has varied due to the sophistication of the local capital markets and the impact of financial regulatory requirements, accounting standards and legal systems. It is anticipated that securitization will continue to expand internationally, albeit at varying rates in each country. AMBAC Indemnity insures both asset-backed and structured transactions, as well as sovereign ad sub-sovereign debt issues, in selected international markets. AMBAC INDEMNITY CORPORATION AMBAC Indemnity is organized into two business divisions, the Public Finance Division and the Specialized Finance Division. PUBLIC FINANCE DIVISION The Public Finance Division is responsible for underwriting insurance and maintaining client relationships for the following types of municipal bonds: general obligation, tax-backed, transportation, leases, utilities, higher education and airports. During 1996 and 1995, the Public Finance Division was responsible for insured gross par written of $19.0 billion and $13.7 billion, respectively. As of December 31, 1996, net par outstanding related to the Public Finance Division was $86.3 billion. During 1995, the Public Finance Division was reorganized along regional lines, with a team of underwriters assigned to each of three regions of the United States; North, South and West. Prior to the reorganization, underwriters were assigned to an underwriting group based on the type of obligation insured. Management believes the change to a regional focus promotes closer ties to issuers, financial advisors and bankers who now deal with the same team of professionals in each region, regardless of the type of obligation being insured. Within the Public Finance Division, the management of credit decisions and criteria is centralized in the Credit Management Group. This group, in conjunction with the Public Finance Senior Credit Committee, seeks to assure that credit criteria are maintained, are appropriate and are systematically and consistently applied across the regions. The Public Finance Portfolio Risk Management Group reviews the division's insured portfolio for concentration of risk, whether in specific bond types, geographically or by size of issue. This group is also responsible for portfolio surveillance within the Public Finance Division. Analysts and others responsible for portfolio surveillance, schedule and execute regular and ad hoc reviews of credits in the book of business. Risk adjusted surveillance strategies have been developed for each bond type. Review periods and scope of review vary by bond type based upon the risk inherent in the nature of the credits. The focus of the surveillance review is to determine credit trends and recommend appropriate classification and review periods. Generally, the surveillance reviews are performed by analysts having the same experience and authority as those reviewing issues for initial underwriting. Compliance with this process is monitored by the head of Public Finance Portfolio Risk Management. 6 AMBAC Indemnity assigns internal ratings to individual exposures as part of the new issue underwriting process and at surveillance reviews. These internal ratings, which represent AMBAC Indemnity's independent judgments, are based upon underlying credit parameters similar to those used by nationally recognized rating agencies. SPECIALIZED FINANCE DIVISION The Specialized Finance Division is responsible for underwriting insurance and maintaining client relationships for the following types of financings: structured transactions; receivable securitizations; asset-backed commercial paper conduits; home equity and mortgage-backed securities; bonds of state housing and student loan agencies, health care institutions and investor- owned utilities. Underwriters in the Specialized Finance Division are organized into teams of experienced professionals with expertise in a specific type of security. During 1996 and 1995, the Specialized Finance Division was responsible for insured gross par written of $17.8 billion and $12.4 billion, respectively. As of December 31, 1996, net par outstanding related to the Specialized Finance Division was $45.2 billion. The Specialized Finance Division is also responsible for underwriting all transactions with international exposure, primarily in Europe. During 1996 and 1995, AMBAC Indemnity insured gross par written in international transactions of $3.7 billion and $1.2 billion, respectively. As of December 31, 1996, net par outstanding related to international risks was $4.3 billion. Geographically, the countries receiving AMBAC Indemnity's primary international focus have been France and the United Kingdom. The types of international obligations insured primarily have been asset-backed securities, sovereign and sub-sovereign obligations, and special revenue and infrastructure obligations. Management has developed underwriting standards for international risks which are consistent with those applied to risks in the United States. In addition management believes that the international risks insured to date are largely similar in risk type to those insured in the United States. In September 1995, AMBAC Indemnity and MBIA Insurance Corporation ("MBIA") formed an unincorporated joint venture, MBIA/AMBAC International, to market financial guarantee insurance in Europe. The joint venture was formed with the goal of bringing the combined capital and human resources of the two companies together to more efficiently serve the European markets. Since the inception of the joint venture, the two companies have insured a combined total par amount of approximately $7.0 billion related to international risks under the joint venture. Under the joint venture, financial guarantee policies are issued separately by each of the companies. While retaining the right to act individually, each company has the opportunity to reinsure up to 50 percent of the financial guarantee business written by the other company in Europe as part of the joint venture. Customer preference, licensing and market considerations determine which company insures a transaction. In January 1997, AMBAC Indemnity capitalized a new subsidiary in the United Kingdom, AMBAC Insurance UK Limited ("AMBAC UK"), which was authorized on February 4, 1997 to carry on certain classes of general insurance business in the United Kingdom. Beginning in 1997, AMBAC UK will be the primary vehicle for directly issuing financial guarantee policies in the United Kingdom and Europe. AMBAC Indemnity and AMBAC UK have entered into a net worth maintenance agreement and reinsurance agreements. 7 As is the case with the Public Finance Division, the management of credit decisions and criteria in the Specialized Finance Division is centralized in the Risk Management Group. This group, in conjunction with the Specialized Finance Senior Credit Committee, seeks to assure that credit criteria are appropriate and systematically applied across the division. The Risk Management Group is responsible for overseeing the surveillance process, setting and monitoring standards for quality, timing and documentation of credit reviews. Analysts responsible for portfolio surveillance schedule and execute regular and ad hoc reviews of credits in the book of business. Risk adjusted surveillance strategies have been developed for each bond type. Review periods and scope of review vary by bond type based upon the risk inherent in the nature of the credits. In certain cases, portfolio surveillance may be the responsibility of the underwriting departments that originate the transactions. The focus of the surveillance review is to determine credit trends, recommend appropriate classification and set the next review date. Compliance with this process is monitored by the head of Specialized Finance Risk Management. INSURANCE WRITTEN AMBAC Indemnity provides financial guarantee insurance for municipal bonds, including taxable municipal bonds and structured finance obligations. AMBAC Indemnity's financial guarantee insurance is delivered in two markets: the new issue market and the secondary market. New issue insurance includes municipal bond insurance, insurance of structured finance obligations, insurance of debt service reserve funds, assumed reinsurance and insurance of other financial obligations. The secondary market includes insurance of municipal bonds, structured finance obligations, bonds in mutual funds and unit investment trusts ("UITs"). The following table indicates the gross par amount written for each of the years, 1996, 1995 and 1994 with respect to each market: 1996 1995 1994 -------- --------- ---------- ($ In Millions) New issue market.. . . . . . . . . . . $35,384 $23,630 $19,692 Secondary market.. . . . . . . . . . . 1,434 2,339 2,394 ------- ------- ------- $36,818 $25,969 $22,086 ======= ======= ======= NEW ISSUE MARKET - MUNICIPAL AMBAC Indemnity sells the majority of its insurance in the new issue municipal bond market. Of the $35.4 billion, $23.6 billion and $19.7 billion of new issue par exposure written in 1996, 1995 and 1994, respectively, $25.3 billion, $18.0 billion and $17.9 billion, respectively, was new issue municipal bond exposure. In the new issue municipal bond market, an issuer typically pays a single premium to AMBAC Indemnity at the time the policy is issued. Premiums are based on the total amount of principal and interest that will become 8 due during the life of the bonds and on AMBAC Indemnity's evaluation of the inherent strength and credit quality of the issuer. Insurance premium rates take into account the risk assumed by the insurer. Critical factors in assessing risk include the credit quality of the issuer, type of issue, the repayment source, the type of security pledged, the presence of restrictive covenants and the length of maturity. Each bond issue is evaluated in accordance with, and the final premium rate is a function of, the particular factors as they relate to such issue. Charges for new issue insurance also take into account the benefits to be obtained by the issuer, as well as the cost and the projected return to AMBAC Indemnity. Proposed new municipal bond issues are submitted to AMBAC Indemnity to determine their insurability by issuers or by their investment bankers or financial advisors. Municipal bond issues are sold on either a competitive or a negotiated basis. With respect to competitive issues, an issuer will publish a notice of sale soliciting bids for the purchase of a proposed issue of municipal bonds. Various syndicates are then formed by potential bidders on the bonds. These syndicates then solicit a determination from some or all of the financial guarantee insurers whether an issue is insurable and at what premium rate and on what terms. The syndicate then determines whether to bid on the issue with insurance (and if so, with which insurer) or without insurance. The issuer then generally selects the syndicate with the lowest bid. In a negotiated offering, an individual investment banker or team of investment bankers has already been selected by the issuer and that banker or team then typically solicits premium quotes and terms from the insurers. The new issue market includes insurance policies designed to satisfy debt service reserve fund requirements of municipal bond issuers. These policies insure the availability of an amount not to exceed the debt service reserve fund requirement for the issues, which in most cases is the lesser of one year's maximum principal and interest payments or approximately 10% of the original principal amount of a bond issue. Any amounts drawn under the debt service reserve fund policy must be reimbursed by the issuer within a specified time period and at a specified interest rate. NEW ISSUE MARKET - STRUCTURED FINANCE Of the $35.4 billion, $23.6 billion and $19.7 billion of new issue par exposure written in 1996, 1995 and 1994, respectively, $10.1 billion, $5.6 billion and $1.8 billion was new issue structured finance bond exposure. Premiums for structured finance policies are based on a percentage of either principal or principal and interest insured. The timing of the collection of structured finance premiums varies among individual transactions; some being collected in a single payment at policy inception date, and others being collected periodically (i.e., monthly, quarterly or annually). As of December 31, 1996 and 1995, net outstanding par exposure related to structured finance transactions was $12.4 billion and $5.5 billion, respectively. SECONDARY MARKET Insurance on bonds outstanding in the secondary market is typically purchased by an institution to facilitate the sale of municipal bonds in its portfolio or inventory. The insurance generally increases the sale price of bonds (typically by an amount greater than the cost of the policy) and affords a wider secondary market and therefore greater marketability 9 to a given issue of previously-issued bonds. As is the case with new issues, the premium is generally payable in full at the time of policy issuance. AMBAC Indemnity employs the same underwriting standards on secondary market issues that it does on new municipal bond issues. However, AMBAC Indemnity is more selective in the types of bonds it will insure in the secondary market. Secondary market insurance can be riskier for a more complex legal structure since the insurer does not have the ability to influence restrictive covenants at the time of issuance. Consequently, AMBAC Indemnity concentrates its secondary market insurance efforts on insurance of general obligation and utility revenue bonds, in addition to issues where AMBAC Indemnity has existing exposure. Sponsors of UITs contact AMBAC Indemnity for insurance on individual bonds in a specific trust. Insurance policies on individual bonds in insured UITs are effective only as long as such bonds remain in the UIT unless an additional premium is paid to extend their effective date to the stated maturity of the bonds. AMBAC Indemnity insures individual bonds in insured mutual funds. Insurance policies on individual bonds in insured mutual funds are effective only as long as the individual bonds remain in the fund. Premiums on bonds included in mutual funds are collected monthly. INSURANCE IN FORCE AMBAC Indemnity underwrites and prices financial guarantee insurance on the assumption that the insurance will remain in force until maturity of the insured bonds. AMBAC Indemnity estimates that the average life (as opposed to the stated maturity) of its insurance policies on new issue par in force at December 31, 1996 was 12.5 years. The 12.5 year average life is determined by applying a weighted average calculation, using the remaining years to maturity of each insured bond, and weighting them on the basis of the remaining par insured. No assumptions are made for any prepayment of insured bonds or for any future refundings of insured issues. Municipal bonds generally have provisions that allow the issuer to prepay all or a portion of the outstanding amount prior to maturity. AMBAC Indemnity seeks to maintain a diversified insurance portfolio designed to spread its risk based on a variety of criteria, including (i) issue size, (ii) type of bond, (iii) geographic area and (iv) issuer. As of December 31, 1996, the total net par amount of insured bonds outstanding was $131.5 billion. This amount excludes (a) AMBAC Indemnity's guarantees for the timely payment of principal and interest on obligations under municipal investment contracts issued by the MIC business and (b) AMBAC Indemnity's policies which guarantee the obligations of AFS and its counterparties under AFS's interest rate swaps. As of December 31, 1996, the aggregate amount of municipal investment contracts insured was $2.74 billion, including accrued interest. The insurance policies covering the MIC business are collateralized by the MIC business' investment securities, accrued interest, securities purchased under agreements to resell and cash and cash equivalents, which as of December 31, 1996, had a fair value of $2.78 billion in the aggregate. As of December 31, 1996, the total amount of guarantees covering AFS and its swap counterparties was not material. See "Financial Services" below. 10 ISSUE SIZE AMBAC Indemnity seeks a broad coverage of the market by insuring small and large issues alike. AMBAC Indemnity's insured exposure as of December 31, 1996 reflects the emphasis on issues insured with an original par amount of less than $25 million, which reduces AMBAC Indemnity's average per-issue exposure to losses. The following table sets forth the distribution of AMBAC Indemnity's insured portfolio as of December 31, 1996 with respect to the original size of each insured issue: ORIGINAL PAR AMOUNT PER ISSUE AS OF DECEMBER 31, 1996
% OF TOTAL NET PAR % OF TOTAL NET NUMBER OF AMOUNT PAR AMOUNT ORIGINAL PAR AMOUNT NUMBER OF ISSUES ISSUES OUTSTANDING OUTSTANDING - ---------------------------- ---------------- -------- ------------ ------------ ($ In Millions) Less than $10 million...... 7,959 73% $ 23,544 18% $10-25 million............. 1,579 14 20,994 16 $25-50 million............. 757 7 22,623 17 Greater than $50 million... 683 6 64,336 49 ------ --- -------- --- 10,978 100% $131,497 100% ====== === ======== ===
11 TYPES OF BONDS The table below shows the distribution by bond type of AMBAC Indemnity's insured portfolio as of December 31, 1996. As the table illustrates, approximately 42% of AMBAC Indemnity's net par amount outstanding at December 31, 1996, consisted of general obligation bonds and utility revenue bonds, which generally present less credit risk than other types of municipal bonds. AMBAC Indemnity tries to avoid insuring bond issues which entail excessive single project risk, over-capacity or customer contract disputes. For a more detailed discussion of the various types of obligations in AMBAC Indemnity's insured portfolio, see "Types and Ratings of Bonds" attached as Appendix A hereto. INSURED PORTFOLIO BY BOND TYPE AS OF DECEMBER 31, 1996
% OF TOTAL NET NET PAR AMOUNT PAR AMOUNT BOND TYPE OUTSTANDING OUTSTANDING - ---------------------------------------- ------------------- ------------------ ($ In Millions) MUNICIPAL FINANCE: General obligation.................... $ 31,863 24 % Lease and tax-backed revenue.......... 25,366 19 Utility revenue....................... 22,780 18 Health care revenue................... 13,521 10 Transportation revenue................ 6,891 5 Investor-owned utilities.............. 5,551 4 Higher education...................... 4,745 4 Housing revenue....................... 4,497 3 Student loans......................... 3,439 3 Other................................. 484 1 ------------------- ------------------ Total municipal finance............ 119,137 91 ------------------- ------------------ STRUCTURED FINANCE: Domestic:............................. Mortgage-backed and home equity..... 5,263 4 Asset-backed........................ 1,329 1 Other............................... 1,440 1 ------------------- ------------------ Total domestic structured finance.. 8,032 6 ------------------- ------------------ International:........................ Asset-backed........................ 2,530 2 Other............................... 1,798 1 ------------------- ------------------ Total international structured 4,328 3 finance........................... ------------------- ------------------ Total structured finance......... 12,360 9 ------------------- ------------------ Total.......................... $131,497 100% =================== ==================
12 The table below shows the percentage, by bond type, of new business insured by AMBAC Indemnity during each of the last five years. During this period, AMBAC Indemnity has consistently emphasized insurance of general obligation bonds, utility revenue bonds and tax-backed revenue bonds and has maintained a decreasing but substantial proportion of its insured volume in such bond types. NEW BUSINESS INSURED BY BOND TYPE (1)
BOND TYPE 1992 1993 1994 1995 1996 - --------------------------------------- --------- ------ -------- ------- ------- MUNICIPAL FINANCE: General obligation..................... 36% 29% 29% 23% 16% Utilities (2).......................... 27 26 21 16 15 Lease and tax-backed revenue........... 13 21 16 16 23 Health care revenue.................... 8 13 8 8 7 Housing revenue........................ 2 2 5 5 3 Transportation revenue................. 8 3 5 5 3 Student loans.......................... 2 1 4 5 3 Higher education....................... 3 3 4 3 3 Other.................................. 1 0 1 0 0 --------- ------ -------- ------- ------- Total municipal finance.............. 100 98 93 81 73 --------- ------ -------- ------- ------- STRUCTURED FINANCE: Domestic: Mortgage-backed and home equity............................... 0 0 1 8 12 Asset-backed.......................... 0 0 0 5 4 Other................................. 0 2 1 1 3 --------- ------ -------- ------- ------- Total domestic structured finance............................. 0 2 2 14 19 --------- ------ -------- ------- ------- International: Asset-backed.......................... 0 0 1 2 6 Other................................. 0 0 4 3 2 --------- ------ -------- ------- ------- Total international structured finance.................. 0 0 5 5 8 --------- ------ -------- ------- ------- Total structured finance............. 0 2 7 19 27 --------- ------ -------- ------- ------- Total.............................. 100% 100% 100% 100% 100% ========= ====== ======== ====== =======
(1) Stated as a percentage of total net par amount insured during such year. (2) Includes investor-owned utilities. GEOGRAPHIC AREA AMBAC Indemnity is licensed to write business in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico and Guam. As of December 31, 1996, the six largest states, as measured by net par amount outstanding, accounted for approximately 51% of AMBAC indemnity's total net par amount outstanding. The following table sets forth those states and geographic areas in which AMBAC indemnity's aggregate insured exposure equaled 2% or more of its total net par amount outstanding as of December 31, 1996. 13 INSURED PORTFOLIO BY STATE AS OF DECEMBER 31, 1996
NET PAR % OF TOTAL NET NUMBER OF AMOUNT PAR AMOUNT STATE/GEOGRAPHIC AREA ISSUES OUTSTANDING OUTSTANDING - ----------------------- ----------- --------------- -------------- ($ In Millions) California............. 825 $ 20,536 16% New York............... 965 10,832 8 Florida................ 564 10,169 8 Pennsylvania........... 911 9,559 7 Texas.................. 1,208 8,513 6 Illinois............... 542 7,235 5 Ohio................... 484 5,186 4 New Jersey............. 401 4,633 4 Michigan............... 505 4,624 4 Massachusetts.......... 293 4,147 3 Indiana................ 194 2,799 2 Washington............. 379 2,635 2 Other States........... 3,644 36,301 28 ----------- --------------- -------------- Total domestic.... 10,915 127,169 97 International.......... 63 4,328 3 ----------- --------------- -------------- 10,978 $131,497 100% =========== =============== ===============
ISSUERS AMBAC Indemnity has adopted underwriting and exposure management policies designed to limit the net insurance in force for any one credit. In addition, AMBAC Indemnity uses reinsurance to limit net exposure to any one credit. As of December 31, 1996, AMBAC Indemnity's net par amount outstanding for its 20 largest credits, totaling $9.5 billion, was approximately 7% of AMBAC Indemnity's total net par amount outstanding with no one credit representing more than 1% of AMBAC Indemnity's total net par amount outstanding. AMBAC Indemnity is also subject to certain regulatory limits and rating agency guidelines on exposure to a single credit. See "Insurance Regulatory Matters" and "Rating Agencies" below. UNDERWRITING GUIDELINES, POLICIES AND PROCEDURES Underwriting guidelines, policies and procedures have been developed by AMBAC Indemnity's management with the intent that AMBAC Indemnity insure only those obligations which, in the opinion of AMBAC Indemnity analysts, are of investment grade quality. There are instances where one of the major rating agencies will differ with AMBAC Indemnity's assessment of the investment grade nature of a particular obligation or where the underlying rating of an issuer is subsequently downgraded to below investment grade. As of December 31, 1996, AMBAC Indemnity's aggregate outstanding net par insured of below investment grade issues was $860.2 million (or 0.7% of AMBAC Indemnity's total net par amount outstanding of obligations insured). 14 The underwriting process involves review of structural, legal and credit issues, including compliance with current AMBAC Indemnity underwriting standards. These standards are reviewed periodically by management. The rating agencies also monitor the credits underlying AMBAC Indemnity's insurance in force and, in most cases, advise AMBAC Indemnity of the credit rating each issue would receive if it were not insured by AMBAC Indemnity. The following table sets forth AMBAC Indemnity's insured portfolio by rating as of December 31, 1996: INSURED PORTFOLIO BY RATING (1) AS OF DECEMBER 31, 1996
NET PAR % OF TOTAL NET NUMBER OF AMOUNT PAR AMOUNT RATING ISSUES OUTSTANDING OUTSTANDING - ------------------ --------- ----------- --------------- ($ In millions) AAA.............. 63 $ 756 1% AA............... 831 9,564 7 A................ 6,093 88,858 67 BBB.............. 3,891 31,459 24 BIG (2).......... 100 860 1 ------ -------- --- 10,978 $131,497 100% ====== ======== ===
(1) Ratings represent AMBAC Indemnity internal ratings. (2) Represents those bonds which have been categorized as "below investment grade" by AMBAC Indemnity. AMBAC Indemnity's policy is to reduce default risk associated with the obligations insured by it to the extent practicable. The decision to insure an issue is based upon the issuer's ability to repay the bonds, security features and structure, rather than upon an actuarial or statistical prediction of the likelihood that the issuer will default on the underlying debt obligation. AMBAC Indemnity insures only those bonds on which it expects not to incur a loss. However, AMBAC Indemnity's policy is to provide for loss reserves that are adequate to cover potential losses. See "Losses and Reserves" below. Underwriting criteria vary by bond type, reflecting the differences, for example, in economic and social factors, debt management, public purpose essentiality, financial management, legal and administrative factors, revenue sources and security features. All requests for insurance are reviewed by AMBAC Indemnity's underwriting staff, which is divided into two major underwriting divisions. The underwriting process is designed to screen each issue carefully and begins with a thorough credit analysis and written report prepared by the primary analyst assigned to the issue. The report is then reviewed within the primary analyst's underwriting group and division. The primary analyst's recommendation to qualify or reject an issue must be approved by a concurring analyst and an underwriting officer. The number of additional approvals required and the extent of an attorney's involvement in a particular credit depends on the aggregate amount of AMBAC Indemnity's existing or potential exposure to the credit. On large credits, where the aggregate exposure exceeds a certain pre-determined amount, the insurance decision must be approved by a credit committee comprised of senior underwriting officers and an attorney in addition to the analysts and underwriting officer mentioned above. 15 AMBAC Indemnity determines premium rates on the basis of the bond type and credit strength of the bond issue, the maturity and structure of the issue, and other credit and market factors, including, but not limited to, security features, the presence or absence of a debt service reserve fund or additional credit enhancement features and the interest rate spread between insured and uninsured obligations with characteristics similar to those of the proposed bond issue. Premium rates are based upon established premium ranges, extensive consultation with the analysts responsible for the issue, and market intelligence developed from daily contact with syndicate managers and traders at investment banking firms to help form the most accurate view of the value of AMBAC Indemnity's insurance on each issue. REMEDIAL MANAGEMENT Those issues which are either in default or have developed problems that, with the passage of time, may lead to a claim or loss are tracked closely by the appropriate surveillance team. The documents underlying any problem credit are reviewed by internal or outside counsel and an analysis is prepared outlining AMBAC Indemnity's rights and potential remedies, the duties of all parties involved and recommendations for corrective actions. This analysis, along with the schedule of corrective actions, is reviewed in the monthly remedial credit meetings. AMBAC Indemnity also meets with issuers to reach agreement upon the nature and the scope of the problem and to discuss the issuers' operating plans. In many instances, AMBAC Indemnity, under the terms of the documents governing the underlying obligation, has the ability, among other things, to direct that audits be performed with respect to servicer and trustee contractual responsibilities and to meet with the appropriate officials to outline AMBAC Indemnity's concerns and rights. When the underlying economics so indicate, AMBAC Indemnity may aid in a restructuring to improve the debt service coverage. LOSSES AND RESERVES AMBAC Indemnity's policy is to provide for loss and loss adjustment expense reserves that are adequate to cover potential losses as well as losses that may arise from insured obligations which are currently or imminently in default. The Active Credit Reserve ("ACR") is that portion of the reserves that is based on AMBAC Indemnity's estimate of ultimate aggregate losses inherent in the obligations insured. As of December 31, 1996, AMBAC Indemnity's ACR was $38.6 million. When a default occurs or is imminent with respect to a particular insured obligation, a reserve ("Case Basis Reserve") is established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default and the estimated expenses associated with settling the claims, less estimated recoveries under salvage or subrogation rights. In estimating the losses on defaults, AMBAC Indemnity makes its assessment based on the full term of the insured obligation. All or part of the Case Basis Reserve is allocated from any ACR available for such insured obligation. AMBAC Indemnity's Case Basis Reserves totaled $21.6 million at December 31, 1996. 16 AMBAC Indemnity's reserve for losses and loss adjustment expenses consists of the ACR and Case Basis Reserves. The most recent three-year history of AMBAC Indemnity's loss reserves, and losses and loss adjustment expenses incurred and paid, is described in the table below: RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (1) YEARS ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 ---------- ---------- ----------- ($ In Thousands) Reserve for losses and loss adjustment expenses at January 1,................. $65,996 $65,662 $64,037 Losses and loss adjustment expenses 3,778 3,377 2,593 incurred............................... Losses and loss adjustment expenses paid................................... (9,554) (3,043) (968) ------- ------- ------- Reserve for losses and loss adjustment expenses at December 31,............... $60,220 $65,996 $65,662 ======= ======= ======= (1) All information is net of salvage. Management of AMBAC Indemnity believes that the reserves for losses and loss adjustment expenses are adequate to cover the ultimate net costs of claims, but the reserves are necessarily based on estimates and there can be no assurance that the ultimate liability will not exceed such estimates. See Notes 2 and 5 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. COMPETITION The financial guarantee insurance business is highly competitive. AMBAC Indemnity's principal competitors in the market for municipal bond insurance are three other monoline insurance companies, Financial Guaranty Insurance Company ("FGIC"), Municipal Bond Investors Assurance Corporation ("MBIA") and Financial Security Assurance Inc. ("FSA"). According to AMBAC Indemnity estimates based on industry sources, AMBAC Indemnity, FGIC, MBIA and FSA, in the aggregate, insured approximately 99% of all new issue municipal bonds insured during 1996, with MBIA insuring approximately 40% of such bonds, AMBAC Indemnity insuring approximately 29% of such bonds, FGIC insuring approximately 18% of such bonds and FSA insuring approximately 12% of such bonds. In the structured finance and asset-backed markets, AMBAC Indemnity's principal competitors, in addition to FGIC, MBIA and FSA, is one other monoline insurance company, Capital Markets Assurance Corporation. The principal competitive factors among financial guarantee insurers are (i) premium rates, (ii) conditions precedent to the issuance of a policy related to the structure and security features of a proposed bond issue, (iii) the financial strength of an insurer and (iv) the quality of service provided to issuers, investors and other clients of the issuer. With respect to each of these competitive factors, AMBAC Indemnity believes it is on equal footing with each of its principal competitors in the municipal bond, structured finance and asset-backed markets. Financial guarantee insurance also competes domestically and internationally with other forms of credit enhancement, including letters of credit and guarantees (for example, mortgage guarantees where pools of mortgages secure debt service payments) provided by banks and other financial institutions, some of which are governmental agencies. Letters of credit are most often issued for periods of less than 10 years, although there is no legal restriction on the issuance of letters of credit having longer terms. Thus, financial institutions and banks issuing letters of credit compete directly with AMBAC Indemnity to guarantee short-term notes and bonds with a maturity of less than 10 years. To the extent that banks providing credit enhancement may begin to issue letters of credit with commitments of longer than 10 years, the competitive position of financial guarantee insurers, such as AMBAC Indemnity, could be adversely affected. Letters of credit also are frequently used to assure the liquidity of a short-term put option for a long-term bond issue. This assurance of liquidity effectively confers on such issues, for the short-term, the credit standing of the financial institution providing the facility, thereby competing with AMBAC Indemnity and other financial guarantee insurers in providing interest cost savings on such issues. Financial guarantee insurance and other forms of credit enhancement also compete in nearly all instances with the issuer's alternative of foregoing credit enhancement and paying a higher interest rate. If the interest savings from insurance or another form of credit enhancement do not exceed the cost of such credit enhancement, the issuer will generally choose to issue bonds without enhancement. 17 Multiline insurance companies are not significant direct participants in the financial guarantee industry. Also, under a law enacted in 1989 in New York, multiline insurers are prohibited from writing financial guarantee insurance in New York State, except during a transitional period which, subject to certain specific conditions, will expire in May 1997. Although a significant minimum amount of capital is required of a financial guarantee insurer by the rating agencies in order to obtain triple-A claims-paying ability ratings (at least $100 million), there can be no assurance that major multiline insurers or other financial institutions will not participate in financial guarantee insurance in the future, either directly or through subsidiaries. Under the New York law, a financial guarantee insurance company must have at least $75 million of paid-in capital and surplus and maintain thereafter at least $65 million of policyholders' surplus. A similar law in California imposes a $100 million minimum capital and surplus requirement, with a maintenance requirement thereafter of $75 million. REINSURANCE State insurance laws and regulations (as well as the rating agencies) impose minimum capital requirements on financial guarantee insurance companies, limiting the aggregate amount of insurance which may be written and the maximum size of any single risk exposure which may be assumed. Such companies can use reinsurance to diversify risk, increase underwriting capacity, reduce additional capital needs, stabilize shareholder returns and strengthen financial ratios. See "Insurance Regulatory Matters" below. During 1996 and in prior years, AMBAC Indemnity entered into pro rata reinsurance agreements with certain reinsurers which provided for a combination reinsurance program. Each agreement was divided into a quota share program and a surplus share program. Under each agreement, which was renewed on an annual basis, the reinsurer shared the interests and liabilities of AMBAC Indemnity under all municipal bond business (as defined below) written during the term of the agreement. Municipal bond business was defined as all new issue and secondary market insurance policies written by AMBAC Indemnity which were classified by AMBAC Indemnity as municipal bond insurance and which insured bonds satisfying the definition of municipal bonds contained in the applicable laws and regulations in the States of Wisconsin and New York. Any policy written during the term of the agreement was reinsured for the full term of the policy, even if the reinsurer did not renew its participation in AMBAC Indemnity's reinsurance program for subsequent years. Under the 1996 quota share program, AMBAC Indemnity ceded a percentage of each insured policy. The surplus share program provided a surplus layer of reinsurance in excess of the quota share percentage which increased AMBAC Indemnity's insurance capacity. A ceding commission was withheld to defray AMBAC Indemnity's underwriting expenses under both the quota share program and surplus share program. AMBAC Indemnity has also entered into facultative reinsurance agreements with certain of the same reinsurers that are party to the agreements described above, which allow AMBAC Indemnity to reduce its large risks, to manage its portfolio of insurance by bond type and geographic distribution, and to provide additional capacity for frequent bond issuers. Under these agreements, portions of AMBAC Indemnity's interests and liabilities 18 are ceded on an issue-by-issue basis. A ceding commission is withheld to defray AMBAC Indemnity's underwriting expenses. In addition, AMBAC Indemnity and MBIA, in conjunction with the MBIA/AMBAC joint venture described above, have entered into facultative reinsurance agreements whereupon each company may reinsure the other on risks insured in conjunction with the joint venture. Effective January 1, 1997, AMBAC Indemnity has discontinued the quota share and surplus share reinsurance programs as described above, and will only use facultative reinsurance agreements to reduce its risks and manage its insurance portfolio in the future. As of December 31, 1996, AMBAC Indemnity had retained approximately 85% of its gross insurance in force of $268.9 billion and had ceded approximately 15% to its treaty and facultative reinsurers. See Note 4 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. As a primary insurer, AMBAC Indemnity is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under the various reinsurance agreements with AMBAC Indemnity. To minimize its exposure to significant losses from reinsurer insolvencies, AMBAC Indemnity evaluates the financial condition of its reinsurers, prepares annual written reviews of such reinsurers and monitors for concentrations of credit risk. AMBAC Indemnity's current reinsurers are Aachener Ruckversicherungs, AXA Re Finance, Capital Markets Assurance Corporation, Capital Reinsurance Company, Enhance Reinsurance Company, MBIA and Royal Reinsurance Company, Ltd.. The majority of these reinsurers have long-standing relationships with AMBAC Indemnity. In addition, Aachener Ruckversicherungs, AXA Re Finance and Royal Reinsurance Company, Ltd., are multiline insurance companies which are diversified by the lines of insurance they underwrite. RATING AGENCIES Moody's, S&P, Fitch and Nippon periodically review the business and financial condition of AMBAC Indemnity and other companies providing financial guarantee insurance. These rating agencies' reviews focus on the insurer's underwriting policies and procedures and the quality of the obligations insured. The rating agencies frequently perform assessments of the credits insured by AMBAC Indemnity to confirm that AMBAC Indemnity continues to meet the capital allocation criteria considered necessary by the particular rating agency to maintain AMBAC Indemnity's triple-A claims-paying ability ratings. A rating by Moody's, S&P, Fitch or Nippon, however, is not a "market rating" or a recommendation to buy, hold or sell any security. See "Underwriting Guidelines, Policies and Procedures" above. AMBAC Indemnity's ability to attract new business or to compete with other triple-A rated financial guarantors, and its results of operations and financial condition, would be materially adversely affected by any reduction in its ratings. 19 INSURANCE REGULATORY MATTERS GENERAL LAW AMBAC Indemnity is licensed to do business as an insurance company in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico and Guam. It is subject to the insurance laws and regulations of the State of Wisconsin (the "Wisconsin Insurance Laws"), its state of incorporation, and the insurance laws and regulations of other states in which it is licensed to transact business. These laws and regulations, as well as the level of supervisory authority that may be exercised by the various state insurance departments, vary by jurisdiction, but generally require insurance companies to maintain minimum standards of business conduct and solvency, meet certain financial tests, file certain reports with regulatory authorities, including information concerning their capital structure, ownership and financial condition, and require prior approval of certain changes in control of domestic insurance companies and their direct and indirect parents and the payment of certain dividends and distributions. In addition, these laws and regulations require approval of certain inter-corporate transfers of assets and certain transactions between insurance companies and their direct and indirect parents and affiliates, and generally require that all such transactions have terms no less favorable than terms that would result from transactions between parties negotiating at arm's length. AMBAC Indemnity is required to file quarterly and annual statutory financial statements in each jurisdiction in which it is licensed, and is subject to single and aggregate risk limits and other statutory restrictions concerning the types and quality of investments and the filing and use of policy forms and premium rates. Additionally, AMBAC Indemnity's accounts and operations are subject to periodic examination by the Office of the Commissioner of Insurance of the State of Wisconsin (the "Wisconsin Commissioner") (the last such examination having been conducted in 1992 for the period ended December 31, 1991) and other state insurance regulatory authorities. See Note 8 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. The Company believes that AMBAC Indemnity is in material compliance with all applicable insurance laws and regulations. INSURANCE HOLDING COMPANY LAWS Under the Wisconsin insurance holding company laws, any acquisition of control of the Company and thereby indirect control of AMBAC Indemnity requires the prior approval of the Wisconsin Commissioner. "Control" is defined as the direct or indirect power to direct or cause the direction of the management and policies of a person. Any purchaser of 10% or more of the outstanding voting stock of a corporation is presumed to have acquired control of that corporation and its subsidiaries unless the Wisconsin Commissioner, upon application, determines otherwise. For purposes of this 10% test, the Company believes that a holder of common stock having the right to cast 10% of the votes which may be cast by the holders of all shares of common stock of the Company would be deemed to have control of AMBAC Indemnity within the meaning of the Wisconsin Insurance Laws. 20 Pursuant to these laws, both J.P. Morgan & Co. Incorporated and Harris Associates, L.P. each obtained approval from the Wisconsin Insurance Commissioner to acquire greater than 10% of the Company's outstanding stock. As of December 31, 1996 their respective percentages of ownership were approximately 12.9% and 11.4%. In their respective requests for approval from the Wisconsin Commissioner, each entity disclaimed any present intention to exercise control over the Company or AMBAC Indemnity or to control or attempt to control the management or operations of the Company or AMBAC Indemnity. The Wisconsin insurance holding company laws also require prior approval by the Wisconsin Commissioner of certain transactions between AMBAC Indemnity and companies affiliated with AMBAC Indemnity. WISCONSIN DIVIDEND RESTRICTIONS Pursuant to the Wisconsin Insurance Laws, AMBAC Indemnity may declare dividends, subject to any restriction in its articles of incorporation, provided that, after giving effect to the distribution, it would not violate certain statutory equity, solvency, income and asset tests. Distributions to shareholders (other than stock dividends) must be reported to the Wisconsin Commissioner. Extraordinary dividends must be reported prior to payment and are subject to disapproval by the Wisconsin Commissioner. An extraordinary dividend is defined as a dividend or distribution, the fair market value of which, together with all dividends from the preceding 12 months, exceeds the lesser of (a) 10% of policyholders' surplus as of the preceding December 31 or (b) the greater of (i) statutory net income for the calendar year preceding the date of the dividend or distribution, minus realized capital gains for that calendar year or (ii) the aggregate of statutory net income for the three calendar years preceding the date of the dividend or distribution, minus realized capital gains for those calendar years and minus dividends paid or credited and distributions made within the first two of the preceding three calendar years. On April 30, 1996, AMBAC Indemnity, in conjunction with the sale of the Company's remaining holdings of HCIA common stock, delivered to the Company (in the form of an extraordinary dividend) its 2,378,672 shares of HCIA common stock, at fair value. The Wisconsin Commissioner approved such dividend. As a result, any dividends paid by AMBAC Indemnity to the Company through June 30, 1997 require pre-approval from the Wisconsin Commissioner. The Wisconsin Commissioner has stated to AMBAC Indemnity management that it does not foresee any reason pre-approval of anticipated dividends on the common stock of AMBAC Indemnity to be paid through June 30, 1997 would not be given. Anticipated AMBAC Indemnity common stock dividends paid thereafter and through year-end 1997, will not require such pre-approval. During 1996, AMBAC Indemnity paid to the Company cash dividends on its common stock totaling $40.0 million. See Note 8 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. NEW YORK FINANCIAL GUARANTEE INSURANCE LAW New York's comprehensive financial guarantee insurance law governs the conduct of business of all financial guarantee insurers licensed to do business in New York, 21 including AMBAC Indemnity. This law requires a financial guarantee insurer to contribute to a contingency reserve an amount equal to 50% of premiums as they are earned on a statutory basis on policies written prior to July 1, 1989, and, with respect to policies written on and after July 1, 1989, it must make contributions over a period of 20 years for municipal bonds and 15 years for all other obligations until the contingency reserve for such insured obligations equals the greater of 50% of premiums written for the relevant category of insurance or a percentage of the principal guaranteed, varying from 0.55% to 2.50%, depending upon the type of obligation guaranteed. This reserve must be maintained for the periods specified above, except that withdrawals by the insurer may be permitted under specified circumstances in the event that actual loss experience exceeds certain thresholds or if the reserve accumulated is deemed excessive in relation to the insurer's outstanding insured obligations. Financial guarantee insurers are also required to maintain case basis loss and loss adjustment expense reserves and unearned premium reserves on bases established by the regulations. The New York financial guarantee insurance law establishes single risk limits applicable to all obligations issued by a single entity and backed by a single revenue source. Under the limit applicable to municipal bonds, the insured average annual debt service for a single risk, net of reinsurance and collateral, may not exceed 10% of the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal bonds attributable to any single risk, net of reinsurance and collateral, is limited to 75% of the insurer's policyholders' surplus and contingency reserves. Additional single risk limits, which generally are more restrictive than the municipal bond single risk limit, are also specified for several other categories of insured obligations, including structured finance obligations. Aggregate risk limits are also established on the basis of aggregate net liability and policyholders' surplus requirements. "Aggregate net liability" is defined as outstanding principal and interest of guaranteed obligations insured, net of reinsurance and collateral. Under these limits, policyholders' surplus and contingency reserves must at least equal a percentage of aggregate net liability that is equal to the sum of various percentages of aggregate net liability for various categories of specified obligations. The percentage varies from 0.33% for municipal bonds to 4.00% for certain non-investment grade obligations. FINANCIAL GUARANTEE INSURANCE REGULATION IN OTHER STATES The Wisconsin Insurance Laws have regulations of municipal bond insurers similar in structure to those in effect in New York. Under the Wisconsin regulations, AMBAC Indemnity must establish a contingency reserve in an amount equal to 50% of net statutory earned premium on municipal bond insurance policies. This reserve must be maintained for 20 years. However, the regulations provide that compliance with contingency reserve provisions under statutes in other jurisdictions which result in greater contributions than under the Wisconsin regulations is deemed to constitute compliance with the Wisconsin regulations. The Wisconsin regulations also include certain single and aggregate risk limitations. The average annual debt service for any single issue of municipal bonds may not exceed 10% of AMBAC Indemnity's policyholders' surplus. In addition, AMBAC Indemnity's cumulative net liability, defined as one-third of one percent of the insured unpaid principal and interest covered by current municipal bond insurance policies, 22 may not exceed its qualified statutory capital, which is defined as the sum of its capital and surplus and contingency reserve. California has a financial guarantee insurance law similar in structure and effect to the New York statute. None of the risk limits established in California's legislation with respect to business transacted by AMBAC Indemnity are more stringent in any material respect than the corresponding provisions in the New York financial guarantee insurance statute. California law requires a financial guarantee insurer to contribute to a contingency reserve an amount equal to 50% of premiums as they are earned on a statutory basis on policies written prior to July 1, 1989, and, with respect to policies written on and after July 1, 1989, it must make contributions over a period of 20 years for municipal bonds and 15 years for all other obligations until the contingency reserve for such insured obligations equals a percentage of principal outstanding, varying from 0.80% to 3.00%, depending upon the type of obligation guaranteed. This reserve must be maintained for the periods specified above, except that withdrawals by the insurer may be permitted under specified circumstances in the event that actual loss experience exceeds certain thresholds or if the reserve accumulated is deemed excessive in relation to the insurer's outstanding insured obligations. AMBAC Indemnity's reported contingency reserve is equal to the greater of the required reserve as calculated under New York and California law. In addition to the laws and regulations of New York, Wisconsin and California, AMBAC Indemnity is subject to laws and regulations of other states concerning the transaction of financial guarantee insurance, none of which is more stringent in any material respect than the New York financial guarantee insurance statute. FINANCIAL SERVICES ------------------ The Company's Financial Services Division provides investment contracts, municipal interest rate swaps and investment management and advisory services principally to states, municipalities, municipal authorities and hospitals and health organizations. Financial services revenues are derived from (i) net investment income, (ii) net swap trading revenues, (iii) fund management and advisory revenues, and (iv) realized gains and losses. Excluding transactions with affiliates, total revenues were $22.2 million, $13.0 million and $16.7 million in 1996, 1995 and 1994, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 17 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. The principal competitive factors among providers of municipal investment contracts are (i) contract rates, (ii) conditions precedent to the issuance of a policy related to the structure and security features of a proposed investment contract, (iii) the financial strength of the financial services provider, and (iv) the quality of service provided to issuers, investors and other clients of the issuer. The Company believes that the MIC business competes favorably with respect to each of these factors. The principal competitive factors among providers of municipal interest rate swap contracts are (i) pricing of contracts, (ii) the financial strength of the financial services 23 provider, (iii) the ability to structure a complete financial package, and (iv) the quality of service provided to issuers, investors and other clients of the issuer. The Company believes that AFS competes favorably with respect to each of these competitive factors. The principal competitive factors among providers of investment management and advisory service are (i) pricing of services, (ii) investment returns, (iii) the ability to provide services tailored to customers needs, and (iv) the quality of service provided to customers. The Company believes that Cadre competes favorably with respect to each of these competitive factors. MUNICIPAL INVESTMENT CONTRACT BUSINESS In 1992, the Company formed its MIC business, with the principal purpose of providing municipal investment contracts and municipal investment repurchase contracts primarily to states, municipalities and municipal authorities. Investment contracts are used by municipal bond issuers to invest bond proceeds until such proceeds can be used for their intended purpose, such as financing construction. The municipal investment contract provides for the guaranteed return of principal invested, as well as the payment of interest thereon at a guaranteed rate and is rated triple-A by virtue of AMBAC Indemnity's insurance policy which guarantees the MIC business' performance. The MIC business manages its balance sheet to protect against a number of risks inherent in its business including liquidity, market (principally interest rate) and credit risk. The MIC business' asset-liability guidelines stipulate that the effective duration of the invested assets, including hedges, must be matched to the effective duration of the municipal investment contract liabilities. The MIC business maintains expected cash flow matching of invested assets (including hedges) to funded liabilities in order to minimize market and liquidity risk. A source of liquidity risk is the ability of some counterparties to withdraw moneys on dates other than those specified in the draw down schedule. Liquidity risk is somewhat mitigated by provisions in certain of the municipal investment contracts that limit an issuer's ability to draw on the funds and by risk management procedures that require the regular reevaluation and reprojection of draw down schedules. Investments are restricted to fixed income securities with a minimum average credit quality of Aa/AA. Based upon management's projections, the MIC business maintains funds invested in cash and cash equivalents to meet short term liquidity needs. The MIC business uses interest rate contracts in the normal course of business for hedging purposes as part of its overall interest rate risk management. Several of its interest rate contracts have been entered into with its affiliate, AFS. Interest rate contracts used by the MIC business include financial instruments with off-balance sheet risk such as interest rate futures contracts, interest rate swap agreements and a purchased interest rate option contract. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the financial statements. For further discussion, see Notes 2 and 12 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. 24 Interest rate futures contracts are commitments to either purchase or sell designated financial instruments at a future date for a specified price and are settled in cash. Initial margin requirements are met in cash or other financial instruments, and changes in the contract values are settled daily. Futures contracts have little credit risk since futures exchanges are the counterparties. Interest rate swap contracts are agreements where the MIC business agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts or the difference between different interest rate indices calculated by reference to an agreed upon notional amount. The MIC business is exposed to credit risk in the event counterparties fail to perform according to the terms of the contractual commitments. The MIC business deals only with counterparties of high credit quality and as such, does not expect any counterparties to fail to meet their obligations. Credit risk is also likely to be a factor on longer term investment contracts where credit deterioration or the default of an issuer would increase the likelihood of early withdrawal of funds. The MIC business and AMBAC Indemnity have various procedures and controls in place to monitor the credit risk of these contracts, including the initial credit approval process and the continuous monitoring of credit exposure. The following table sets forth the net payments due under the MIC business' municipal investment contracts in each of the next five years ending December 31, and the period thereafter, based on expected call dates: OBLIGATIONS UNDER MUNICIPAL INVESTMENT CONTRACTS PRINCIPAL AMOUNT (1) - ---------------------------------------------------------------------------- ($ In Thousands) 1997..................................................... $ 945,960 1998..................................................... 677,213 1999..................................................... 443,880 2000..................................................... 43,234 2001..................................................... 82,174 All later years.......................................... 528,830 ---------- $2,721,291 ========== (1) As of December 31, 1996, the interest rates on these agreements ranged from 4.23% TO 8.14%. AMBAC FINANCIAL SERVICES, LIMITED PARTNERSHIP In 1994, the Company formed AFS with the purpose of providing interest rate swaps primarily to states, municipalities, municipal authorities and other entities in connection with their financings. In addition, AFS also provides interest rate swaps to the MIC business, an affiliate. AFS commenced operations in September 1994 and manages its business with the goal of being market neutral to changes in overall interest rates, while retaining "basis risk," the relationship between changes in floating rate tax-exempt and floating rate taxable interest rates. The interest rate swaps provided by AFS are insured by AMBAC Indemnity through policies which guarantee the obligations of AFS and its counterparties. 25 AFS is a limited partnership. AMBAC Indemnity, the sole limited partner, owns a limited partnership interest representing 90% of the total partnership interests of AFS. AMBAC Financial Services Holdings, Inc. ("AFS Holdings"), a wholly-owned subsidiary of the Company, the sole general partner, owns a general partnership interest representing 10% of the total partnership interest in AFS. Interest rate swaps are agreements to exchange with a counterparty, a stream of periodic payments calculated by reference to agreed upon interest rates, indices and notional amounts. In the ordinary course of business, AFS manages a variety of risks principally (i) credit, (ii) market, (iii) liquidity, (iv) operational, and (v) legal. These risks are identified, measured, and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. Below is a discussion of these risks: (i) Credit risk relates to the ability of counterparties to perform according to the terms of their contractual commitments. Various procedures and controls are in place to monitor the credit risk of interest rate swaps. These include the initial credit approval process, the establishment of credit limits, management approvals and a process that ensures the continuous monitoring of credit exposure. (ii) Market risk relates to the impact of price changes on future earnings. This risk is a consequence of AFS's market-making activities in the municipal interest rate swap market. The principal market risk is basis risk, the relationship between changes in floating rate tax-exempt and floating rate taxable interest rates. Since the third quarter of 1995, all municipal interest rate swaps transacted contain provisions which are designed to protect AFS against certain forms of tax reform, thus mitigating its basis risk. An independent risk management group monitors trading risk limits and, together with senior management, is involved in the application of risk measurement methodologies. The estimation of potential losses arising from adverse changes in market relationships, known as "value-at-risk," is a key element in managing market risk. AFS has developed a value-at-risk methodology to estimate potential losses over a specified holding period and based on certain probabilistic assessments. AFS estimates value at risk utilizing historical short-term and long-term interest rate volatilities and the relationship between changes in tax-exempt and taxable interest rates calculated on a consistent daily basis. AFS's value- at-risk, calculated at a 99% confidence level, averaged approximately $1.4 million in both 1996 and 1995. AFS's value-at-risk ranged from a high of $2.6 million to a low of $1.1 million for 1996 and from a high of $2.1 million to a low of $0.7 million for 1995. Since no single measure can capture all dimensions of market risk, AFS bolsters its value at risk methodology by performing daily analyses of parallel and non-parallel shifts in yield curves and stress test scenarios which measure the potential impact of market conditions, however improbable, which might cause abnormal volatility swings or disruptions of market relationships. (iii) Liquidity risk relates to the possible inability to satisfy contractual obligations when due. This risk is present in swaps and in futures contracts used to hedge swaps. AFS 26 manages liquidity risk by maintaining cash and cash equivalents, closely matching the dates swap payments are made and received, and limiting the amount of risk hedged by futures contracts. (iv) Operational risk relates to the potential for loss caused by a breakdown in information, communication, and settlement systems. AFS mitigates operational risk by maintaining a comprehensive system of internal controls. This includes the establishment of systems and procedures to monitor transactions and positions, documentation and confirmation of transactions, ensuring compliance with regulations. (v) Legal risk relates to the uncertainty of the enforceability, through legal or judicial processes, of the obligations of AFS's counterparties, including contractual provisions intended to reduce credit exposure by providing for the offsetting or netting of mutual obligations. AFS seeks to remove or minimize such uncertainties through continuous consultation with internal and external legal advisers, to analyze and understand the nature of legal risk, to improve documentation, and to strengthen transaction structure. For further discussion, see Notes 2 and 13 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. CADRE FINANCIAL SERVICES, INC. Effective December 31, 1996, the Company completed its acquisition of certain assets including the name and assumption of certain liabilities of Cadre Financial Services, Inc. ("Cadre"). Cadre is registered as an investment adviser with the Securities and Exchange Commission and with certain states that currently require such registration. As a registered adviser, Cadre is subject to regulation in certain aspects of its business, particularly with respect to advisory activities on behalf of investment companies. Cadre provides administrative services to money market funds which were established to enable qualified participants, primarily school districts and municipalities, to pool available moneys for investment. At December 31, 1996, Cadre was providing investment administration services for approximately 2,600 clients with approximately $5.9 billion in assets. Marketing and investment advisory services are also provided to the participants of these and other registered funds. Included in the assets under administration at December 31, 1996, were approximately $1.9 billion of assets for which Cadre provides direct investment advisory services. Other investment services are provided to fund participants including placing certificates of deposit with qualified financial institutions and purchasing commercial paper, bankers' acceptances and U.S. government securities through dealers. Fees from the money market funds for which Cadre performs services are based on percentages of the average daily net assets of such funds. Fees for placement of certificates of deposit and other fixed-rate investments on behalf of participants in funds are based on the value and time to maturity of the related investment. Fixed-rate investment fees are recorded upon placement of the instrument since, at that time, substantially all of Cadre's obligations have been fulfilled. 27 INVESTMENTS AND INVESTMENT POLICY As of December 31, 1996, the consolidated investments of the Company had an aggregate fair value of $5.2 billion and an aggregate amortized cost of $5.1 billion. These investments are managed internally by officers of the Company and its subsidiaries, who are experienced investment managers. In the normal course of business, the Company uses interest rate contracts for hedging purposes as part of its overall interest rate risk management. These interest rate contracts include interest rate futures contracts, interest rate swap agreements and purchased interest rate option contracts. All investments, including interest rate contracts, are effected in accordance with the general objectives and guidelines for investments established by each subsidiary's Board of Directors, including guidelines relating to quality, risk concentration and holding period. These guidelines are periodically reviewed and revised as appropriate. Pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities 115," the Company has designated all investments as "available-for-sale" and reports them at fair value. Unrealized gains and losses are excluded from earnings and reported as a separate component of stockholders' equity, net of tax. As of December 31, 1996, AMBAC Indemnity's investment portfolio had an aggregate fair value of $2.5 billion and an aggregate amortized cost of $2.4 billion. The investment policy established by the Board of Directors of AMBAC Indemnity for its investments is designed to achieve diversification of the portfolio and generally to preclude investments in obligations insured by AMBAC Indemnity. AMBAC Indemnity's current investment policy only permits investment in investment grade fixed-income securities, consistent with its goal to achieve the highest after-tax, long-term return. This policy takes into consideration AMBAC Indemnity's desire for both current income and long-term capital growth. AMBAC Indemnity is subject to limits on types and quality of investments imposed by the insurance laws and regulations of the States of Wisconsin and New York. In compliance with these laws, AMBAC Indemnity's Board of Directors approves each specific investment transaction of AMBAC Indemnity. See "Insurance Regulatory Matters -- General Law" above. As of December 31, 1996, the MIC business' investment portfolio had an aggregate fair value of $2.6 billion and an aggregate amortized cost of $2.6 billion. The investment policy established by the Board of Directors of the MIC business for its investments is designed to achieve the highest after-tax return on equity, subject to minimum average quality ratings. The MIC business also uses interest rate contracts for hedging purposes as part of its overall interest rate risk management. For further discussion, see "Municipal Investment Contract Business." 28 The following tables set forth certain information concerning the investments of the Company: INVESTMENTS BY RATING (1) AS OF DECEMBER 31, 1996 % OF INVESTMENT RATING PORTFOLIO - ---------------------------------------------- ---------------- AAA (2)....................................... 62% AA............................................ 17 A............................................. 20 BBB........................................... 1 Not Rated.. - ------- 100% ======= (1) Ratings represent S&P categories. (2) Includes U.S. Treasury and agency obligations, which comprised approximately 33% of the total investment portfolio. SUMMARY OF INVESTMENTS AS OF DECEMBER 31,
---------------------------------------------------------------------------------------------- 1996 1995 1994 ----------------------------- ------------------------------ --------------------------- WEIGHTED WEIGHTED WEIGHTED CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE INVESTMENT CATEGORY VALUE YIELD (1)(2) VALUE YIELD (1)(2) VALUE YIELD(1)(2) - -------------------------- ---------- -------------- --------- --------------- --------- ------------ ($ In Thousands) Long-term investments: Taxable bonds............. $3,105,120 6.69% $2,605,001 6.91% $2,174,075 6.47% Tax-exempt bonds.......... 1,982,911 6.21 1,659,903 6.17 1,452,104 6.35 ----------- ---------- ---------- Total long-term investments............ 5,088,031 6.52 4,264,904 6.59 3,626,179 6.42 Short-term investments (3). 112,511 5.24 176,689 5.72 137,975 5.49 ---------- ---------- ---------- Total investments....... $5,200,542 6.46% $4,441,593 6.56% $3,764,154 6.39% ========== ========== ==========
(1) Yields presented include assets held in the MIC business portfolio. Interest expense on related municipal investment contracts was $154.5 million, $127.6 million and $92.4 million in 1996, 1995 and 1994, respectively. (2) Yields are stated on a pre-tax basis, based on average amortized cost. Yields on tax-exempt bonds represent taxable equivalent yields. (3) Includes taxable and tax-exempt investments. 29 INVESTMENTS BY SECURITY TYPE AS OF DECEMBER 31,
------------------------------------------------------------------------------------------------------ 1996 1995 1994 --------------------------------- ---------------------------------- --------------------------------- WEIGHTED WEIGHTED WEIGHTED CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE INVESTMENT CATEGORY VALUE YIELD (1) (2) VALUE YIELD (1) (2) VALUE YIELD (1)(2) - -------------------------- --------------- -------------- -------------- ------------- ------------ -------------- ($ In Thousands) Municipal obligations...... $1,982,911 6.21% $1,659,903 6.17% $1,452,104 6.35% Corporate securities....... 963,890 7.56 828,060 7.67 525,444 7.82 U.S. government obligations 102,430 6.09 227,425 6.51 109,709 6.75 Mortgage- and asset-backed securities (includes U.S. Government Agency obligations) (3).......... 2,035,115 6.35 1,549,516 6.48 1,538,922 5.96 Other...................... 3,685 3.50 -- -- -- -- -------------- --------------- ----------- Total long-term investments............ 5,088,031 6.52 4,264,904 6.59 3,626,179 6.42 Short-term investments (4). 112,511 5.24 176,689 5.72 137,975 5.49 -------------- --------------- ---------------- Total investments....... $5,200,542 6.46% $4,441,593 6.56% $3,764,154 6.39% ============== =============== ===============
(1) Yields presented include assets held in the MIC business portfolio. Interest expense on related municipal investment contracts was $154.5 million, $127.6 million and $92.4 million in 1996, 1995 and 1994, respectively. (2) Yields are stated on a pre-tax basis, based on average amortized cost. Yields on tax-exempt bonds represent taxable equivalent yields. (3) The actual maturity dates of mortgage-backed securities are uncertain because the underlying mortgages may be paid prior to the stated maturity of such securities. This possibility of pre-payment creates the risk that the Company will be unable to replace such investments with securities of comparable yield. (4) Includes taxable and tax-exempt investments. DISTRIBUTION OF INVESTMENTS BY MATURITY AS OF DECEMBER 31, 1996 AMORTIZED ESTIMATED MATURITY COST FAIR VALUE - ---------------------------------------- ----------- ----------- ($ In Thousands) Due in one year or less (1)............. $ 140,921 $ 141,028 Due after one year through five years... 344,615 354,696 Due after five years through ten years.. 279,108 290,987 Due after ten years..................... 2,291,165 2,378,716 ---------- ---------- 3,055,809 3,165,427 Mortgage- and asset-backed securities (2).................................... 2,035,719 2,035,115 ---------- ---------- Total investments....................... $5,091,528 $5,200,542 ========== ========== (1) Includes long-term investments in the amount of $28.4 million maturing within one year. (2) The actual maturity dates of mortgage- and asset-backed securities are uncertain because the underlying mortgages may be paid prior to the stated maturity of such securities. This possibility of pre-payment creates the risk that the Company will be unable to replace such investments with securities of comparable yield. 30 For further discussion, see Note 3 of Notes to Consolidated Financial Statements in the Company's 1996 Annual Report to Stockholders. EMPLOYEES As of December 31, 1996, the Company and its subsidiaries had 225 employees. None of the employees is covered by collective bargaining agreements. The Company considers its employee relations to be satisfactory. ITEM 2. PROPERTIES. The principal executive offices of the Company are located at One State Street Plaza, New York, New York 10004. The telephone number is (212) 668-0340. AMBAC Indemnity maintains its principal executive offices at One State Street Plaza, New York, New York 10004, which consists of approximately 97,000 square feet of office space, under an agreement which expires on September 30, 2014. AMBAC Indemnity also maintains offices in London, England and Westport, Connecticut. The MIC business and AFS maintain their principal executive offices at 300 Nyala Farms Road, Westport, Connecticut 06880. This office space consists of approximately 21,000 square feet under a lease agreement which expires on March 31, 2005. The lease contains one option to renew for an additional period of five years. Cadre maintains its principal executive office at 905 Marconi Avenue, Ronkonkoma, New York 11779. The office building was acquired by the Company as part of the acquisition of Cadre. It consists of approximately 15,000 square feet of office space and storage. In addition, the Company owns certain interests in real estate acquired in connection with the defeasance of AMBAC Indemnity's policy obligations with respect to certain industrial revenue bonds. ITEM 3. LEGAL PROCEEDINGS. There are no material lawsuits pending, or to the knowledge of the Company threatened, to which the Company or any of its majority-owned subsidiaries is a party. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS. There were no matters submitted to a vote of security holders during the fourth quarter of 1996. 31 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Information relating to the principal market on which the Company's Common Stock is tradable, the high and low sales prices per share for each full quarterly period within the two most recent fiscal years, and the frequency and amount of any cash dividends declared for the two most recent fiscal years is set forth on page 52 of the Company's 1996 Annual Report to Stockholders and such information is incorporated herein by reference. Information concerning restrictions on the payment of dividends is set forth in Item 1 above under the caption "Insurance Regulatory Matters - Wisconsin Dividend Restrictions." As of March 21, 1997, there were 101 stockholders of record of the Company's Common Stock, which is listed on the New York Stock Exchange. On December 31, 1996, the Company issued 214,192 shares of its Common Stock ("Private Shares") to Cadre Financial Services, Inc. ("Cadre") in exchange for substantially all of its assets and its name. The aggregate amount of assets acquired for the Private Shares plus cash totaled approximately $20.0 million, including goodwill. The Private Shares were issued in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. Cadre represented to the Company that it acquired the Private Shares for its own account and not with a view to, or for resale in connection with, a distribution except to its shareholders. Cadre and each shareholder represented to the Company that its knowledge and experience in financial and business matters was such that Cadre and each shareholder was capable of evaluating the merits and risks of the investment. Each Cadre shareholder agreed that it will not transfer, sell or otherwise dispose of the Private Shares, except as permitted under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA. Selected financial data for the Company and its subsidiaries for each of the last five fiscal years is set forth under the caption "Financial Highlights" on page 3 of the Company's 1996 Annual Report to Stockholders. Such information is incorporated herein by reference and should be read in conjunction with the Consolidated Financial Statements and the Notes thereto contained on pages 30 to 49 of such Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Management's Discussion and Analysis of Financial Condition and Results of Operations is set forth under the same caption on pages 21 through 28 of the Company's 1996 Annual Report to Stockholders. Such information is incorporated herein by reference and should be read in conjunction with the Consolidated Financial Statements and the Notes thereto contained on pages 30 to 49 of such Annual Report. 32 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The 1996 Consolidated Financial Statements, together with the Notes thereto and the Independent Auditors' Report thereon, are set forth on pages 29 through 49 of the Company's 1996 Annual Report to Stockholders. Such information is incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information relating to the Company's directors and executive officers is set forth on pages 7, 8, 10, 11 and 23 to 24 of the Company's 1996 Proxy Statement and such information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. Information relating to compensation of the Company's directors and executive officers is set forth on pages 9 and 10 and on pages 12 to 18 of the Company's 1997 Proxy Statement and such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information relating to security ownership of certain beneficial owners and management is set forth on pages 5 to 7 of the Company's 1997 Proxy Statement and such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information relating to certain relationships and related transactions is set forth on page 10 of the Company's 1997 Proxy Statement and such information is incorporated herein by reference. 33 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (A) DOCUMENTS FILED AS A PART OF THIS REPORT: 1. Financial Statements -------------------- The following consolidated financial statements included in the 1996 Annual Report to Stockholders are incorporated herein by reference under Part II, Item 8: PAGE NUMBER IN ANNUAL REPORT ------------- Independent Auditors' Report................................. 29 Consolidated Balance Sheets as of December 31, 1996 and 1995................................... 30 Consolidated Statements of Operations for each of the years ended December 31, 1996, 1995 and 1994......................................................... 31 Consolidated Statements of Stockholders' Equity for each of the years ended December 31, 1996, 1995 and 1994................................................ 32 Consolidated Statements of Cash Flows for each of the years ended December 31, 1996, 1995 and 1994............................. 33 Notes to Consolidated Financial Statements................................................... 34-49 2. Financial Statement Schedules ----------------------------- The financial statement schedules filed herein, which are the only schedules required to be filed, are as follows: Independent Auditors' Report (Page S-1) Schedule I -- Summary of Investments Other Than Investments in Related Parties (Page S-2) Schedule II -- Condensed Financial Information of Registrant (Parent (Pages S-3 Company Only) to S-5) Schedule IV -- Reinsurance (Page S-6) 34 3. Exhibits ----------- The following items are annexed as exhibits: Exhibit Number Description --------------- ----------- 3.01 Conformed Restated Certificate of Incorporation of the Company filed with the Secretary of State of the State of Delaware on June 7, 1991. (Filed as Exhibit 3.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-40306) and incorporated herein by reference.) 3.02 Amendment to the Restated Certificate of Incorporation of the Company filed with the Secretary of State of the State of Delaware on June 22, 1992. (Filed as Exhibit 3.02 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.) 3.03 By-laws of the Company, as amended on January 29, 1997. 4.01 Definitive Engraved Stock Certificate representing shares of Common Stock. (Filed as Exhibit 4.01 to the Company's Registration Statement on Form S-1 (Reg. No. 33-45201) and incorporated herein by reference.) 4.02 Definitive Engraved Stock Certificate representing shares of Common Stock, as amended. (Filed as Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1996 and incorporated herein by reference.) 4.03 Indenture, dated as of August 1, 1991, between the Company and The Chase Manhattan Bank (National Association), Trustee. (Filed as Exhibit 4.01 to the Company's Registration Statement on Form S-3 (Reg. No. 33-59290) and incorporated herein by reference.) 4.04 Rights Agreement, dated as of January 31, 1996, between AMBAC Inc. and Citibank N.A., as Rights Agent, including all exhibits thereto. (Filed as Exhibit 1 to the Company's Registration Statement on Form 8-A dated February 27, 1996 and incorporated herein by reference.) 35 10.01(a)* Amendment and Restated Employment Agreement dated as of December 31, 1994, between the Company and Phillip B. Lassiter. (Filed as Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1995, and incorporated herein by reference.) 10.01(b)* Amendment to Amended and Restated Employment Agreement dated as of January 29, 1997 between the Company and Phillip B. Lassiter. 10.02* AMBAC Inc. 1991 Stock Incentive Plan (as amended through January 29, 1997). 10.03* AMBAC Inc. 1991 Non-Employee Directors Stock Plan. (Filed as Exhibit 10.09 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.) 10.04* Amended and Restated Form of Award and Cancellation Agreement, dated as of June 5, 1992. (Filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.) 10.05* AMBAC Inc. Deferred Compensation Plan for Outside Directors and Eligible Senior Officers, effective as of December 1, 1993 and amended as of December 30, 1994. (Filed as Exhibit 10.14 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995 and incorporated herein by reference.) 10.06(a)* Form of Management Retention Agreement dated as of December 30, 1994. (Filed as Exhibit 10.13 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1995, and incorporated herein by reference.) 10.06(b)* Form of Amendment to Management Retention Agreement dated as of January 29, 1997. 10.07* The AMBAC Inc. Non-Qualified Savings Incentive Plan (effective as of January 1, 1995). (Filed as Exhibit 10.16 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.) - ------------------------- * Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. ---------- 36 10.08* AMBAC Inc. Excess Benefits Pension Plan (Amended and Restated as of January 1, 1994) (As amended through October 25, 1995). (Filed as Exhibit 10.17 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.) 10.09* AMBAC Inc. Supplemental Pension Plan (Amended and Restated as of January 1, 1995) (As amended through October 25, 1995). (Filed as Exhibit 10.18 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.) 10.10 Lease Agreement, dated as of January 1, 1992 between South Ferry Building Company and AMBAC Indemnity Corporation. (Filed as Exhibit 10.36 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992 and incorporated herein by reference.) 10.11 Tax Settlement Agreement, dated as of March 30, 1993, among Citicorp, Citibank, N.A., Citicorp Financial Guaranty Holdings, Inc., AMBAC Inc., AMBAC Indemnity Corporation, American Municipal Bond Holding Company and Health Care Investment Analysts, Inc. (Filed as Exhibit 10.02 to the Company's Registration Statement on Form S-3 (Registration No. 33-59290) and incorporated herein by reference.) 10.12 Second Amended and Restated U.S. $100,000,000 Credit Agreement, dated as of July 21, 1995 (the "BNS Credit Agreement") among the Company and AMBAC Indemnity Corporation as the Borrowers, Certain Commercial Lending Institutions as the Lenders, The Bank of Nova Scotia, acting through its New York Agency, and Citibank, N.A., as the Co-Agents for the Lenders, and The Bank of Nova Scotia, acting through its New York Agency, as the Administrative Agent. (Filed as Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1995 and incorporated herein by reference.) 10.13 Credit Agreement, dated December 2, 1993 (the "Deutsche Bank Credit Agreement") between AMBAC Indemnity Corporation and Deutsche Bank AG (New York Branch), Individually and as Agent. (Filed as Exhibit 10.09 to the Company's Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.) - ---------------------------------------- *Management contractt or compensatory plan, contract or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. 37 10.14 Amendment No. 1 to the Deutsche Bank Credit Agreement, dated as of December 2, 1994 between AMBAC Indemnity Corporation and Deutsche Bank AG, New York Branch, Individually and as Agent. (Filed as Exhibit 10.11 to the Company's Report on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.) 10.15 Amendment No. 2 to the Deutsche Bank Credit Agreement, dated as of December 1, 1995, between AMBAC Indemnity Corporation and Deutsche Bank AG, New York Branch, Individually and as Agent. (Filed as Exhibit 10.15 to the Company's Report on Form 10-K for the year ended December 31, 1995, and incorporated herein by reference.) 10.16 Amendment No. 3 to the Deutsche Bank Credit Agreement, dated as of December 2, 1996, between AMBAC Indemnity Corporation and Deutsche Bank AG, New York Branch, Individually and as Agent. 10.17 Amendment No. 4 to the Deutsche Bank Credit Agreement, dated as of February 14, 1997, between AMBAC Indemnity Corporation and Deutsche Bank AG, New York Branch, Individually and as Agent. 10.18 Letter Agreement, dated as of August 1, 1996 between Gregory & Hoenemeyer, Inc. and AMBAC Capital Corporation. (Filed as Exhibit 10.17 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and incorporated herein by reference.) 11.00 Statement re computation of per share earnings. 13.01 Annual Report to Stockholders for the fiscal year ended December 31, 1996. (Furnished for the information of the Securities and Exchange Commission and not deemed "filed" as part of this Form 10-K except for those portions which are expressly incorporated by reference.) 21.01 List of Subsidiaries of AMBAC Inc. 24.01 Power of Attorney from Phillip B. Lassiter. 24.02 Power of Attorney from Michael A. Callen. 24.03 Power of Attorney from Renso L. Caporali. 24.04 Power of Attorney from Richard Dulude. 24.05 Power of Attorney from W. Grant Gregory. 38 24.06 Power of Attorney from C. Roderick O'Neil. 27.00 Financial Data Schedule. (b) REPORTS ON FORM 8-K: There were no reports on Form 8-K filed during the fourth quarter of 1996. -------- However, on February 14, 1997, the Company filed a Current Report on Form 8-K -------- with its January 30, 1997 press release containing unaudited financial information and accompanying discussion for the three months ended December 31, 1996 and the year ended December 31, 1996. On March 12, 1997, the Company filed a Current Report on Form 8-K containing the consolidated financial statements -------- (with independent auditors' report thereon) of AMBAC Indemnity Corporation and Subsidiaries as of December 31, 1996 and 1995. 39 SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AMBAC INC. (Registrant) Dated: March 31, 1997 By: /s/ Frank J. Bivona ----------------------------- Name: Frank J. Bivona Title: Senior Vice President, Chief Financial Officer and Treasurer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date - --------- -------- ------- Phillip B. Lassiter* Chairman, President March 31, 1997 - --------------------------- and Chief Executive Officer Phillip B. Lassiter and Director (Principal Executive Officer) /s/ Frank J. Bivona Senior Vice President, March 31, 1997 - --------------------------- Chief Financial Officer and Frank J. Bivona Treasurer (Principal Financial and Accounting Officer) Michael A. Callen* Director March 31, 1997 - --------------------------- Michael A. Callen Renso L. Caporali* Director March 31, 1997 - --------------------------- Renso L. Caporali Richard Dulude* Director March 31, 1997 - --------------------------- Richard Dulude W. Grant Gregory* Director March 31, 1997 - --------------------------- W. Grant Gregory C. Roderick O'Neil* Director March 31, 1997 - --------------------------- C. Roderick O'Neil - --------------------- * Frank J. Bivona, by signing his name hereto, does hereby sign this Annual Report on Form 10-K on behalf of each of the directors and officers of the Registrant after whose typed names asterisks appear pursuant to powers of attorney duly executed by such directors and officers and filed with the Securities and Exchange Commission as exhibits to this report. By: /s/ Frank J. Bivona ---------------------- Frank J. Bivona Attorney-in-fact 40 APPENDIX A TYPES AND RATINGS OF BONDS TYPES OF BONDS INSURED - MUNICIPAL General Obligation Bonds. These bonds are supported by the general ------------------------ obligation of the issuer to pay from available funds and by a pledge of the issuer to levy property taxes sufficient in amount to provide for the full payment of the bonds. Utility Revenue Bonds. This category includes primarily revenue bonds --------------------- supported by a pledge of revenues from municipal utility systems that supply basic services to the community. In most cases the utility systems are subject to little competition, if any. These issuers typically have control over their utility rates and are required by their bond indentures to raise rates as necessary to meet certain debt service coverage requirements. This category also includes bonds secured by revenues of major power generation or regional water or sewer facilities which serve many local utilities. Tax-Backed Revenue Bonds. This category includes a wide range of issues ------------------------ secured by various municipal taxes (including sales and excise taxes), assessments and fees. Bond proceeds are typically used for local municipal purposes such as the construction of roads and municipal buildings. Health Care Revenue Bonds. This category includes both long-term issues ------------------------- for capital construction of hospitals and medium-term pool issues for hospital equipment purchase purposes. Transportation Revenue Bonds. This category includes a range of revenue ---------------------------- bonds, including revenue bonds for airports, toll roads, bridges, tunnels and parking facilities. Investor-Owned Utilities. This category includes bonds that are sold by ------------------------ electric, gas and water utilities, generally secured by a first mortgage lien on the utility's assets and are payable from the utility revenues derived from the sale of an essential service. Higher Education Bonds. This category includes both public and private ---------------------- college and university bonds issued to finance general university improvements or specific projects the payment of which is secured by the general credit of the institution, tuition or unrestricted revenues, student fees or auxiliary enterprise fees. Student Loan Bonds. These bonds include issues to finance the origination ------------------ of student loans or the purchase of student loans from eligible lenders in the state and are often insured by state guarantee agencies and reinsured by the federal government through the Department of Education. A-1 Housing Revenue Bonds. This category includes both multi-family and --------------------- single-family housing bonds which exhibit multi-tiered security structures based on the underlying mortgages, reserve funds, and various combinations of features which might include FHA or private mortgage insurance, bank letters of credit, the general obligation of the issuing housing agency and, in some cases, a state's "moral obligation" (that is, not a legally binding commitment) to make up deficiencies. TYPES OF BONDS INSURED - STRUCTURED FINANCE AND ASSET-BACKED Asset-Backed Obligations. These obligations are typically issued in ------------------------ connection with transactions in which the securities being issued are secured by or payable from a specific pool of assets, such as residential mortgages and high quality corporate trade receivables and securities, having an ascertainable cash flow or market value and held by a special purpose issuing entity. While most asset-backed obligations are secured by or represent interest in pools of assets, some of these asset-backed obligations can be secured by one or a few assets. Home Equity Security. A financial instrument whose collateral and source -------------------- of repayment consist of a pool of individual home equity loans. Such loans may have a first or second lien position, or be unsecured. Mortgage Backed Security. A financial instrument whose collateral and ------------------------ source of repayment consist of a pool of individual residential first mortgage loans. Sovereign Obligation. The financial obligation, such as a bond or note, of -------------------- a national government. Special Revenue Bond. A bond whose sole source of repayment is the -------------------- revenues derived from a specific project, such as a toll road or a mass transit system, financed with such bonds. Such bonds typically have no recourse to any other entity, government or taxing authority. Subsovereign Obligation. The financial obligation, such as a bond or note, ----------------------- of the government of a political subdivision of a country, such as a state or department. TYPES OF PROGRAMS New issue insurance. The insurance of bonds at the time of issuance by the ------------------- issuer of the bonds. Unit investment trust insurance. The insurance of individual bonds ------------------------------- deposited into a unit investment trust while such bonds remain in the unit investment trust, unless an additional premium is paid to extend the insurance coverage to the stated maturity of the bonds. Secondary market insurance. The insurance of individual bonds outstanding -------------------------- in the secondary market. A-2 Mutual fund insurance. The insurance of individual bonds in insured mutual --------------------- funds. Insurance policies on individual bonds in insured mutual funds are effective only as long as the individual bonds remain in the fund. Debt service reserve fund insurance. Insurance, by means of a debt service ----------------------------------- reserve fund surety policy, designed to satisfy debt service reserve fund requirements of municipal bond issuers. The surety policy insures the availability of an amount not to exceed the debt service reserve fund requirement for the issues, which in most cases is the lesser of (a) one year's maximum principal and interest payments and (b) approximately 10% of the original principal amount of a bond issue. Structured finance insurance. The insurance of various types of asset- ---------------------------- backed and mortgage-backed financings. A-3 RATINGS OF BONDS The following descriptions of credit ratings applicable to bonds are taken from more extensive explanations provided by Standard & Poor's Ratings Group, Moody's Investors Service, Inc., Fitch Investors Service, L.P. and Nippon Investors Service, Inc. All bonds given a rating of BBB or Baa or better are considered by S&P, Moody's, Fitch, and Nippon to be investment grade. STANDARD & POOR'S RATINGS GROUP DEBT RATINGS AAA: Debt rated "AAA" has the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. AA: Debt rated "AA" has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in a small degree. A: Debt rated "A" has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB: Debt rated "BBB" is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "CC" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. A-4 MOODY'S INVESTORS SERVICE, INC. DEBT RATINGS Aaa: Bonds which are rated "Aaa" are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be anticipated are most unlikely to impair the fundamentally strong position of such issues. Aa: Bonds which are rated "Aa" are judged to be of high quality by all standards. Together with the "Aaa" group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation in protective elements may be of greater amplitude or there may be other elements present which make the long-term risk appear somewhat larger than in Aaa securities. A: Bonds which are rated "A" possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa: Bonds which are rated "Baa" are considered to be medium grade obligations: that is, they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba: Bonds which are rated "Ba" are judged to have speculative elements: their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. A-5 FITCH INVESTORS SERVICE, L.P. DEBT RATINGS AAA: Debt rated "AAA" are bonds considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonable foreseeable events. AA: Debt rated "AA" are bonds considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated "AAA." A: Debt rated "A" are bonds considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB: Debt rated "BBB" are bonds considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have an adverse impact on these bonds and, therefore, impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "CC" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. Plus (+) or Minus (-) signs are used with a rating symbol to indicate the relative position of a credit within the rating category. Plus and minus signs, however, are not used in the "AAA" category. A-6 NIPPON INVESTORS SERVICE, INC. DEBT RATINGS AAA: Debt rated "AAA" are bonds with the highest degree of certainty regarding the discharge of debt, even under adverse circumstances. AA: Debt rated "AA" are bonds with an extremely strong degree of certainty regarding the discharge of debt, even under adverse circumstances. A: Debt rated "A" are bonds with a strong degree of certainty regarding the discharge of debt, even under adverse circumstances. BBB: Debt rated "BBB" are bonds with an adequate degree of certainty regarding the discharge of debt. However, it can be affected by major adverse changes in circumstances. BB, B, CCC, CC, C: Debt rated "BB", "B", "CCC", "CC" or "C" are bonds with varying degrees of uncertainty regarding the discharge of debt. "BB" indicates the lowest degree of uncertainty and therefore the lowest probability of default, "C" the highest degree of uncertainty, and therefore the highest probability of default. Plus (+) or Minus (-) signs may be added to ratings from "AA" through "B" to indicate the relative standing within each of these categories. A-7 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders AMBAC Inc.: Under the date of January 30, 1997, we reported on the consolidated balance sheets of AMBAC Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996, as contained in the 1996 Annual Report to Stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1996. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG Peat Marwick LLP New York, New York January 30, 1997 S-1 AMBAC INC. AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1996 (DOLLAR AMOUNTS IN THOUSANDS)
AMOUNT AT WHICH SHOWN AMORTIZED ESTIMATED IN THE BALANCE TYPE OF INVESTMENT COST FAIR VALUE SHEET - -------------------------------------- ---------- ----------- -------------- U.S. Government obligations............. $ 102,774 $ 102,430 $ 102,430 Municipal obligations................... 1,897,518 1,982,911 1,982,911 Mortgage- and asset-backed securities (includes U.S. Government Agency obligations)........................... 2,035,719 2,035,115 2,035,115 Corporate securities.................... 939,312 963,890 963,890 Other fixed maturities.................. 116,205 116,196 116,196 ---------- ---------- ---------- Total investments.................. $5,091,528 $5,200,542 $5,200,542 ========== ========== ==========
S-2 AMBAC INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) CONDENSED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
1996 1995 ------------- ------------ ASSETS Assets: Cash................................... $ 9 $ 28 Investments in subsidiaries............ 1,716,328 1,631,886 Bonds, at fair value (amortized cost of $104,925 in 1996 and $0 in 1995)...................... 107,338 -- Short-term investments, at cost (approximates fair value)............. 15,722 11,137 Current income taxes receivable........ 3,066 -- Other assets........................... 5,106 3,751 ---------- ---------- Total assets.......................... $1,847,569 $1,646,802 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Current income taxes payable........... $ -- $ 7,377 Debentures............................. 223,798 223,732 Accrued interest payable............... 6,797 6,825 Accounts payable and other liabilities. 1,958 4,880 ---------- ---------- Total liabilities..................... 232,553 242,814 ---------- ---------- Stockholders' equity: Preferred stock, par value $0.01 per share; authorized shares - 4,000,000; issued and outstanding shares - none... -- -- Common Stock, Class A shares, par value $0.01 per share; authorized shares - 20,000,000; issued and outstanding shares - none.......................... -- -- Common Stock, par value $0.01 per share; authorized shares - 50,000,000; issued shares - 35,340,192 at December 31, 1996 and at December 31, 1995...... 353 353 Additional paid-in capital.............. 498,401 492,495 Unrealized gains on investments, net of tax.................................... 58,911 102,470 Retained earnings....................... 1,072,418 819,479 Common Stock held in treasury at cost, 249,807 shares at December 31, 1996 and 276,619 at December 31, 1995....... (15,067) (10,809) ---------- ---------- Total stockholders' equity.......... 1,615,016 1,403,988 ---------- ---------- Total liabilities and stockholders' equity............................ $1,847,569 $1,646,802 ========== ==========
S-3 AMBAC INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS THREE YEARS ENDED DECEMBER 31, (DOLLAR AMOUNTS IN THOUSANDS)
1996 1995 1994 ------------ ----------- ---------- Revenues: Dividend income....................... $ 44,000 $ 40,000 $ 36,000 Extraordinary dividend (1)............ 115,865 -- -- Interest and other income............. 7,589 389 1,841 Net realized gains (losses)........... 66,633 19,103 (2,632) ---------- -------- ------- Total revenues....................... 234,087 59,492 35,209 ---------- -------- ------- Expenses: Interest expense...................... 18,852 19,467 17,469 Operating expenses.................... 3,477 1,531 2,041 ---------- -------- ------- Total expenses....................... 22,329 20,998 19,510 ---------- -------- ------- Income before income taxes and equity in undistributed net income of subsidiaries........................... 211,758 38,494 15,699 Federal income tax expense (benefit).... 18,203 155 (7,890) ---------- -------- ------- Income before equity in undistributed net income of subsidiaries............. 193,555 38,339 23,589 Equity in undistributed net income of subsidiaries........................... 82,762 129,256 117,516 ---------- -------- ------- Net income.............................. 276,317 167,595 141,105 Common dividends........................ (21,500) (19,484) (17,429) Other................................... (1,878) (1,761) (328) Retained earnings at beginning of period 819,479 673,129 549,781 ---------- -------- ------- Retained earnings at end of period...... $1,072,418 $819,479 $673,129 ========== ======== ========
(1) Represents fair value of 2,378,672 shares of HCIA common stock received from AMBAC Indemnity in the form of an extraordinary dividend on April 30, 1996. S-4 AMBAC INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY) CONDENSED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, (DOLLAR AMOUNTS IN THOUSANDS)
1996 1995 1994 ----------- ----------- ------------- Cash flows from operating activities: Net income............................ $ 276,317 $ 167,595 $ 141,105 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in undistributed net income of subsidiaries......................... (82,762) (129,256) (117,516) Extraordinary dividend(1)............. (115,865) -- -- (Decrease) increase in accrued interest payable..................... (28) 28 -- (Gain) loss on sale of investments.... (66,633) (19,103) 2,632 (Decrease) increase in current income taxes payable........................ (10,443) 6,176 (1,552) Other, net............................ (8,292) (941) 3,117 --------- --------- --------- Net cash (used in) provided by operating activities................. (7,706) 24,499 27,786 --------- --------- --------- Cash flows from investing activities: Proceeds from sales of bonds.......... 17,396 -- 17,205 Purchases of bonds.................... (121,734) -- -- Proceeds from sale of affiliate....... 202,609 28,502 -- Change in short-term investments...... (4,585) 2,108 1,591 Other, net............................ 13,842 -- -- --------- --------- --------- Net cash provided by investing activities.......................... 107,528 30,610 18,796 --------- --------- --------- Cash flows from financing activities: Dividends paid........................ (21,500) (19,484) (17,429) Proceeds from issuance of common stock -- -- 164 Purchases of treasury stock........... (31,751) (5,913) (11,907) Proceeds from sale of treasury stock.. 17,211 6,302 709 Contribution to subsidiaries.......... (63,801) (36,001) (18,105) --------- --------- --------- Net cash used in financing activities (99,841) (55,096) (46,568) --------- --------- --------- Net cash flow........................... (19) 13 14 Cash at January 1..................... 28 15 1 --------- --------- --------- Cash at December 31................... $ 9 $ 28 $ 15 ========= ========= ========= Supplemental disclosure of cash flow information: Cash paid during the year for: Income taxes......................... $ 90,197 $ 24,800 $ 30,536 ========= ========= ========= Interest expense..................... $ 19,687 $ 19,687 $ 19,687 ========= ========= ========= Cash received during the year for: Income taxes......................... $ -- $ 8,749 $ 1,167 ========= ========= =========
(1) Represents fair value of 2,378,672 shares of HCIA common stock received from AMBAC Indemnity in the form of an extraordinary dividend on April 30, 1996. S-5 AMBAC INC. AND SUBSIDIARIES SCHEDULE IV - REINSURANCE (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PERCENTAGES)
ASSUMED PERCENTAGE OF CEDED TO FROM AMOUNT GROSS OTHER OTHER NET AMOUNT ASSUMED TO INSURANCE PREMIUMS WRITTEN AMOUNT COMPANIES COMPANIES NET - --------------------------- ------------ -------------- ----------- -------------- -------------- Year ended December 31, 1994...................... $185,365 $(2,815) $4,541 $192,721 2.36% Year ended December 31, 1995...................... $190,570 $28,606 $2,756 $164,720 1.67% Year ended December 31, 1996...................... $240,544 $37,793 $6,664 $209,415 3.18%
S-6 INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION - -------------- ----------- 3.03 By-laws of the Company, as amended on January 29, 1997. 10.01(b)* Amendment to Amended and Restated Employment Agreement dated as of January 29, 1997 between the Company and Phillip B. Lassiter. 10.02* AMBAC Inc. 1991 Stock Incentive Plan (as amended through January 29, 1997). 10.06(b)* Form of Amendment to Management Retention Agreement dated as of January 29, 1997. 10.16 Amendment No. 3 to the Deutsche Bank Credit Agreement, dated as of December 2, 1996, between AMBAC Indemnity Corporation and Deutsche Bank AG, New York Branch, Individually and as Agent. 10.17 Amendment No. 4 to the Deutsche Bank Credit Agreement, dated as of February 14, 1997, between AMBAC Indemnity Corporation and Deutsche Bank AG, New York Branch, Individually and as Agent. 11.00 Statement re computation of per share earnings. 13.01 Annual Report to Stockholders for the fiscal year ended December 31, 1996. (Furnished for the information of the Securities and Exchange Commission and not deemed "filed" as part of this Form 10-K except for those portions which are expressly incorporated by reference.) 21.01 List of Subsidiaries of AMBAC Inc. 24.01 Power of Attorney from Phillip B. Lassiter. 24.02 Power of Attorney from Michael A. Callen. 24.03 Power of Attorney from Renso L. Caporali. 24.04 Power of Attorney from Richard Dulude. 24.05 Power of Attorney from W. Grant Gregory. 24.06 Power of Attorney from C.Roderick O'Neil. 27.00 Financial Data Schedule. * Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. ---------- l-1 EX-3.03 2 BY-LAWS OF THE COMPANY, AS AMENDED 1/29/97 EXHIBIT 3.03 BY-LAWS OF AMBAC INC. Amended as of January 29, 1997
ARTICLE I OFFICES SECTION 1.01 Registered Office ........................................... 1 SECTION 1.02 Other Offices ............................................... 1 ARTICLE II MEETINGS OF STOCKHOLDERS SECTION 2.01 Annual Meetings ............................................. 1 SECTION 2.02 Special Meetings ............................................ 1 SECTION 2.03 Notice of Meetings .......................................... 1 SECTION 2.04 Waiver of Notice ............................................ 2 SECTION 2.05 Adjournments ................................................ 2 SECTION 2.06 Quorum ...................................................... 3 SECTION 2.07 Voting ...................................................... 3 SECTION 2.08 Proxies ..................................................... 3 SECTION 2.09 Chairman and Secretary at Meetings .......................... 3 SECTION 2.10 Judges ...................................................... 3 SECTION 2.11 List of Stockholders ........................................ 4 SECTION 2.12 Notice of Stockholder Business .............................. 4 SECTION 2.13 Notice of Stockholder Nominees .............................. 5 SECTION 2.14 Stockholders' Consent in Lieu of Meeting .................... 6 ARTICLE III BOARD OF DIRECTORS SECTION 3.01 General Powers .............................................. 7 SECTION 3.02 Number and Term of Office ................................... 7 SECTION 3.03 Resignation ................................................. 7 SECTION 3.04 Removal ..................................................... 7 SECTION 3.05 Vacancies ................................................... 7 SECTION 3.06 Meetings .................................................... 8 SECTION 3.07 Committees of the Board ..................................... 9 SECTION 3.08 Directors' Consent in Lieu of Meeting ....................... 10 SECTION 3.09 Action by Means of Telephone or Similar Communications Equipment .................................... 10 SECTION 3.10 Compensation ................................................ 10
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ARTICLE IV OFFICERS Page ---- SECTION 4.01 Officers .................................................... 11 SECTION 4.02 Authority and Duties ........................................ 11 SECTION 4.03 Term of Office, Resignation and Removal ..................... 11 SECTION 4.04 Vacancies ................................................... 11 SECTION 4.05 The Chairman ................................................ 12 SECTION 4.06 The President ............................................... 12 SECTION 4.07 Vice Presidents ............................................. 12 SECTION 4.08 The Secretary ............................................... 12 SECTION 4.09 Assistant Secretaries ....................................... 13 SECTION 4.10 The Treasurer ............................................... 13 SECTION 4.11 Assistant Treasurers ........................................ 13 ARTICLE V CHECKS, DRAFTS, NOTES AND PROXIES SECTION 5.01 Checks, Drafts and Notes .................................... 14 SECTION 5.02 Execution of Proxies ........................................ 14 ARTICLE VI SHARES AND TRANSFERS OF SHARES SECTION 6.01 Certificates Evidencing Shares .............................. 14 SECTION 6.02 Stock Ledger ................................................ 14 SECTION 6.03 Transfers of Shares ......................................... 15 SECTION 6.04 Addresses of Stockholders ................................... 15 SECTION 6.05 Lost, Destroyed and Mutilated Certificates .................. 15 SECTION 6.06 Regulations ................................................. 16 SECTION 6.07 Fixing Date for Determination of Stockholders of Record ...................................................... 16 ARTICLE VII SEAL SECTION 7.01 Seal ........................................................ 16
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Page ---- ARTICLE VIII FISCAL YEAR SECTION 8.01 Fiscal Year ................................................. 16 ARTICLE IX INDEMNIFICATION AND INSURANCE SECTION 9.01 Indemnification ............................................. 17 SECTION 9.02 Insurance for Indemnification ............................... 19 ARTICLE X AMENDMENTS SECTION 10.01 Amendments ................................................. 20
iii BY-LAWS OF AMBAC INC. ARTICLE I OFFICES SECTION 1.01 Registered Office. The registered office of AMBAC Inc. (the "Corporation") in the State of Delaware shall be at the principal office of The Corporation Trust Company in the City of Wilmington, County of New Castle, and the registered agent in charge thereof shall be The Corporation Trust Company. SECTION 1.02 Other Offices. The Corporation may also have an office or offices at any other place or places within or without the State of Delaware as the Board of Directors of the Corporation (the "Board") may from time to time determine or the business of the Corporation may from time to time require. ARTICLE II MEETINGS OF STOCKHOLDERS SECTION 2.01 Annual Meetings. The annual meeting of Stockholders (as defined in Section 2.03) of the Corporation for the election of directors of the Corporation ("Directors"), and for the transaction of such other business as may properly come before such meeting, shall be held at such place, date and time as shall be fixed by the Board and designated in the notice or waiver of notice of such annual meeting. SECTION 2.02 Special Meetings. Special meetings of Stockholders for any purpose or purposes may be called by the Board or the Chairman of the Board of the Corporation (the "Chairman"), the President of the Corporation (the "President") or the Secretary of the Corporation (the "Secretary"), to be held at such place, date and time as shall be designated in the notice or waiver of notice thereof. SECTION 2.03 Notice of Meetings. (a) Except as otherwise provided by law, written notice of each annual or special meeting of Stockholders stating the place, date and time of such meeting and, in the case of a special meeting, the purpose or purposes for which such meeting is to be held, shall be given personally or by first-class mail (airmail in the case of international communications) to each By-laws of AMBAC Inc. Amended as of 1/29/97 Page 2 recordholder of shares of common stock of the Corporation issued and outstanding ("Shares") entitled to vote thereat, not less than 10 nor more than 90 days before the date of such meeting. If mailed, such notice shall be deemed to be given when deposited in the United States mail, postage prepaid, directed to the recordholder of Shares (a "Stockholder") at such Stockholder's address as it appears on the records of the Corporation. If, prior to the time of mailing, the Secretary shall have received from any Stockholder a written request that notices intended for such Stockholder are to be mailed to some address other than the address that appears on the records of the Corporation, notices intended for such Stockholder shall be mailed to the address designated in such request. (b) Notice of a special meeting of Stockholders may be given by the person or persons calling the meeting, or, upon the written request of such person or persons, such notice shall be given by the Secretary on behalf of such person or persons. If the person or persons calling a special meeting of Stockholders give notice thereof, such person or persons shall deliver a copy of such notice to the Secretary. Each request to the Secretary for the giving of notice of a special meeting of Stockholders shall state the purpose or purposes of such meeting. SECTION 2.04 Waiver of Notice. Notice of any annual or special meeting of Stockholders need not be given to any Stockholder who files a written waiver of notice with the Secretary, signed by the person entitled to notice, whether before or after such meeting. Neither the business to be transacted at, nor the purpose of, any meeting of Stockholders need be specified in any written waiver of notice thereof. Attendance of a Stockholder at a meeting, in person or by proxy, shall constitute a waiver of notice of such meeting, except when such Stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business on the grounds that the notice of such meeting was inadequate or improperly given. SECTION 2.05 Adjournments. Whenever a meeting of Stockholders, annual or special, is adjourned to another date, time or place, notice need not be given of the adjourned meeting if the date, time and place thereof are announced at the meeting at which the adjournment is taken. If the adjournment is for more than 30 days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each Stockholder entitled to vote thereat. At the adjourned meeting, any business may be transacted which might have been transacted at the original meeting. Any previously scheduled meeting of the Stockholders may be postponed, and (unless the Certificate of Incorporation of the Corporation (the "Certificate of Incorpo- By-laws of AMBAC Inc. Amended as of 1/29/97 Page 3 ration") otherwise provides) any special meeting of the Stockholders may be cancelled, by resolution of the Board upon public notice given prior to the date previously scheduled for such meeting of Stockholders. SECTION 2.06 Quorum. Except as otherwise provided by law or the Certificate of Incorporation, the recordholders of a majority of the Shares entitled to vote thereat, present in person or by proxy, shall constitute a quorum for the transaction of business at all meetings of Stockholders, whether annual or special. If, however, such quorum shall not be present in person or by proxy at any meeting of Stockholders, the presiding officer at the meeting of the Stockholders entitled to vote thereat may adjourn the meeting from time to time in accordance with Section 2.05 hereof until a quorum shall be present in person or by proxy. SECTION 2.07 Voting. Each Stockholder shall be entitled to one vote for each Share held of record by such Stockholder. Except as otherwise provided by law or the Certificate of Incorporation, when a quorum is present at any meeting of Stockholders, the vote of the recordholders of a majority of the Shares constituting such quorum shall decide any question brought before such meeting. SECTION 2.08 Proxies. Each Stockholder entitled to vote at a meeting of Stockholders or to express, in writing, consent to or dissent from any action of Stockholders without a meeting may authorize another person or persons to act for such Stockholder by proxy. Such proxy shall be filed with the Secretary before such meeting of Stockholders or such action of Stockholders without a meeting, at such time as the Board may require. No proxy shall be voted or acted upon more than three years from its date, unless the proxy provides for a longer period. SECTION 2.09 Chairman and Secretary at Meetings. At any meeting of Stockholders, the Chairman, or in his absence, the President, or if neither such person is available, then a person designated by the Board, shall preside at and act as chairman of the meeting. The Secretary, or in his absence a person designated by the chairman of the meeting, shall act as secretary of the meeting. SECTION 2.10 Judges. The votes at each meeting of Stockholders shall be supervised by not less than two judges who shall decide all questions respecting the qualification of voters, the validity of the proxies and the acceptance or rejection of votes. The judges shall be appointed by the Board but if, for any reason, there are less than two judges present and acting at any meeting, the By-laws of AMBAC Inc. Amended as of 1/29/97 Page 4 chairman of the meeting shall appoint an additional judge or judges so that there shall always be at least two judges to act at the meeting. SECTION 2.11 List of Stockholders. A complete list of the Stockholders entitled to vote at each meeting of Stockholders, arranged in alphabetical order, and showing the address and number of shares registered in the name of each Stockholder, shall be prepared and made available for examination during regular business hours by any Stockholder for any purpose germane to the meeting. The list shall be available for such examination for a period of not less than ten days prior to the meeting and during the whole time of the meeting either at a place within the city where the meeting is to be held, which place shall be specified in the notice of meeting or, if not so specified, at the place where the meeting is to be held. SECTION 2.12 Notice of Stockholder Business. At an annual meeting of the Stockholders, only such business shall be conducted as shall have been brought before the meeting (a) by or at the direction of the Board or (b) by any Stockholder who complies with the notice procedures set forth in this Section 2.12. For business to be properly brought before an annual meeting by a Stockholder, the Stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a Stockholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than sixty days nor more than ninety days prior to the meeting; provided, however, that in the event that less than seventy days' notice or prior public disclosure of the date of the meeting is given or made to the Stockholders, notice by the Stockholder to be timely must be received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made. A Stockholder's notice to the Secretary shall set forth as to each matter the Stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting; (b) the name and address, as they appear on the Corporation's books, of the Stockholder proposing such business; (c) the class and number of shares of the Corporation which are beneficially owned by the Stockholder; and (d) any material interest of the Stockholder in such business. Notwithstanding anything in these By-laws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2.12. The chairman of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this By-laws of AMBAC Inc. Amended as of 1/29/97 Page 5 Section 2.12, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 2.12, a Stockholder seeking to have a proposal included in the Corporation's proxy statement shall comply with the requirements of Regulation 14A under the Securities Exchange Act of 1934, as amended (including, but not limited to, Rule 14a-8 or its successor provision). SECTION 2.13 Notice of Stockholder Nominees. Only persons who are nominated in accordance with the procedures set forth in these By-laws shall be eligible for election as Directors. Nominations of persons for election to the Board may be made at a meeting of Stockholders (a) by or at the direction of the Board or (b) by any Stockholder entitled to vote for the election of Directors at the meeting who complies with the notice procedures set forth in this Section 2.13. Nominations by Stockholders shall be made pursuant to timely notice in writing to the Secretary of the Corporation. To be timely, a Stockholder's notice shall be delivered to or mailed and received at the principal executive offices of the Corporation not less than sixty days nor more than ninety days prior to the meeting; provided, however, that in the event that less than seventy days' notice or prior public disclosure of the date of the meeting is given or made to Stockholders, notice by the Stockholder to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made. Such Stockholder's notice shall set forth (a) as to each person whom the Stockholder proposes to nominate for election or re-election as a Director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person's written consent to being named in the proxy statement as a nominee and to serving as a Director if elected); and (b) as to the Stockholder giving the notice (i) the name and address, as they appear on the Corporation's books, of such Stockholder and (ii) the class and number of shares of the Corporation which are beneficially owned by such Stockholder. At the request of the Board any person nominated by the Board for election as a Director shall furnish to the Secretary that information required to be set forth in a Stockholder's notice of nomination which pertains to the nominee. No person shall be eligible for election as a Director unless nominated in accordance with the procedures set forth in these By-laws. The chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the By-laws of AMBAC Inc. Amended as of 1/29/97 Page 6 procedures prescribed by these By-laws, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded. SECTION 2.14 Stockholders' Consent in Lieu of Meeting. (a) Consents to Corporate Action. Any action which is required to be or may be taken at any annual or special meeting of Stockholders, subject to the provisions of Subsections (b) and (c) of this Section 2.14, may be taken without a meeting, without prior notice and without a vote if consents in writing, setting forth the action so taken, shall have been signed by the holders of the outstanding Shares having not less than the minimum number of votes that would be necessary to authorize or to take such action at a meeting at which all Shares entitled to vote thereon were present and voted; provided, however, that prompt notice of the taking of the corporate action without a meeting and by less than unanimous written consent shall be given to those Stockholders who have not consented in writing. (b) Determination of Record Date of Action by Written Consent. The record date for determining Stockholders entitled to express consent to corporate action in writing without a meeting shall be fixed by the Board. Any Stockholder of record seeking to have the Stockholders authorize or take corporate action by written consent without a meeting shall, by written notice to the Secretary, request the Board to fix a record date. Upon receipt of such a request, the Secretary shall place such request before the Board at its next regularly scheduled meeting, provided, however, that if the Stockholder represents in such request that he intends, and is prepared, to commence a consent solicitation as soon as is permitted by the Securities Exchange Act of 1934, as amended, and the regulations thereunder and other applicable law, the Secretary shall, as promptly as practicable, call a special meeting of the Board, which meeting shall be held as promptly as practicable. At such regular or special meeting, the Board shall fix a record date as provided in Section 213(a) (or its successor provision) of the General Corporation Law of the State of Delaware (the "General Corporation Law"). Should the Board fail to fix a record date as provided for in this Subsection (b), then the record date shall be the day on which the first written consent is expressed. (c) Procedures for Written Consent. In the event of the delivery to the Corporation of a written consent or consents purporting to represent the requisite voting power to authorize or take corporate action and/or related revocations, the Secretary shall provide for the safekeeping of such consents and By-laws of AMBAC Inc. Amended as of 1/29/97 Page 7 revocations and shall, as promptly as practicable, engage nationally recognized independent judges of election for the purpose of promptly performing a ministerial review of the validity of the consents and revocations. No action by written consent and without a meeting shall be effective until such judges have completed their review, determined that the requisite number of valid and unrevoked consents has been obtained to authorize or take the action specified in the consents, and certified such determination for entry in the records of the Corporation kept for the purpose of recording the proceedings of meetings of Stockholders. ARTICLE III BOARD OF DIRECTORS SECTION 3.01 General Powers. The business and affairs of the Corporation shall be managed by the Board, which may exercise all such powers of the Corporation and do all such lawful acts and things as are not by law, the Certificate of Incorporation or these By-laws directed or required to be exercised or done by Stockholders. SECTION 3.02 Number and Term of Office. The number of Directors shall be three or such greater number as shall be fixed from time to time by the Board. Directors need not be Stockholders. Directors shall be elected at the annual meeting of Stockholders, and each Director shall hold office until his successor is elected and qualified, or until his earlier death or resignation or removal in the manner hereinafter provided. SECTION 3.03 Resignation. Any Director may resign at any time by giving written notice to the Board, the Chairman or the Secretary. Such resignation shall take effect at the time specified in such notice or, if the time be not specified, upon receipt thereof by the Board, the Chairman or the Secretary, as the case may be. Unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. SECTION 3.04 Removal. Any or all of the Directors may be removed, with or without cause, at any time by vote of the recordholders of a majority of the Shares then entitled to vote at an election of Directors, or by written consent of the recordholders of Shares pursuant to Section 2.14 hereof. SECTION 3.05 Vacancies. Vacancies occurring on the Board as a result of the removal of Directors without cause may be filled only by vote of the By-laws of AMBAC Inc. Amended as of 1/29/97 Page 8 recordholders of a majority of the Shares then entitled to vote at an election of Directors, or by written consent of such recordholders pursuant to Section 2.14 hereof. Vacancies occurring on the Board for any other reason, including, without limitation, vacancies occurring as a result of the creation of new directorships that increase the number of Directors, may be filled by such vote or written consent or by vote of the Board or by written consent of the Directors pursuant to Section 3.08 hereof. If the number of Directors then in office is less than a quorum, such other vacancies may be filled by vote of a majority of the Directors then in office or by written consent of all such Directors pursuant to Section 3.08 hereof. Unless earlier removed pursuant to Section 3.04 hereof, each Director chosen in accordance with this Section 3.05 shall hold office until the next annual election of Directors by the Stockholders and until his successor shall be elected and qualified. SECTION 3.06 Meetings. (a) Annual Meetings. As soon as practicable after each annual election of Directors by the Stockholders, the Board shall meet for the purpose of organization and the transaction of other business, unless it shall have transacted all such business by written consent pursuant to Section 3.08 hereof. (b) Stated Meetings. The Board may provide for stated meetings of the Board. (c) Other Meetings. Other meetings of the Board shall be held at such times as the Chairman, the President, the Secretary or a majority of the Board shall from time to time determine. (d) Notice of Meetings. No notice need be given of any organization or stated meeting of the Board for which the date, hour and place have been fixed by the Board. The Secretary shall give written notice to each Director of each other organization and stated meeting and of all special meetings of the Board, which notice shall state the place, date, time and purpose of such meeting. Notice of each such meeting shall be given to each Director, if by mail, addressed to him at his residence or usual place of business, at least two days before the day on which such meeting is to be held, or shall be sent to him at such place by telecopy, telegraph, cable, or other form of recorded communication, or be delivered personally or by telephone not later than the day before the day on which such meeting is to be held. A written waiver of notice, signed by the Director entitled to notice, whether before or after the time of the meeting referred to in such waiver, shall be deemed equivalent to notice. Neither the business to be transacted at, nor the purpose any meeting of the Board need be specified in any written waiver of By-laws of AMBAC Inc. Amended as of 1/29/97 Page 9 notice thereof. Attendance of a Director at a meeting of the Board shall constitute a waiver of notice of such meeting, except as provided by law. (e) Place of Meetings. The Board may hold its meetings at such place or places within or without the State of Delaware as the Board or the Chairman may from time to time determine, or as shall be designated in the respective notices or waivers of notice of such meetings. (f) Quorum and Manner of Acting. One-third of the total number of Directors then in office (but in no event less than three Directors) shall be present in person at any meeting of the Board in order to constitute a quorum for the transaction of business at such meeting, and the vote of a majority of those Directors present at any such meeting at which a quorum is present shall be necessary for the passage of any resolution or act of the Board, except as otherwise expressly required by law, the Certificate of Incorporation or these By-laws. In the absence of a quorum for any such meeting, a majority of the Directors present thereat may adjourn such meeting from time to time until a quorum shall be present. (g) Organization. At each meeting of the Board, one of the following shall act as chairman of the meeting and preside, in the following order of precedence: (i) the Chairman; (ii) the President; (iii) any Director chosen by a majority of the Directors present. The Secretary or, in the case of his absence, any person (who shall be an Assistant Secretary, if an Assistant Secretary is present) whom the chairman of the meeting shall appoint shall act as secretary of such meeting and keep the minutes thereof. SECTION 3.07 Committees of the Board. The Board may designate one or more committees, each committee to consist of one or more Directors. The Board may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of such committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint By-laws of AMBAC Inc. Amended as of 1/29/97 Page 10 another Director to act at the meeting in the place of any such absent or disqualified member. A majority of the members of any committee of the Board shall be present in person at any meeting of the committee in order to constitute a quorum for the transaction of business at such meeting, and the act of a majority of the members present at any such meeting at which a quorum is present shall be the act of the committee. In the absence of a quorum for any such meeting, a majority of the members present thereat may adjourn such meeting from time to time until a quorum shall be present. Any committee of the Board, to the extent provided in the resolution of the Board designating such committee, shall have and may exercise all the powers and authority of the Board in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; provided, however, that no such committee shall have such power or authority in reference to the following matters: (i) approving or adopting, or recommending to the stockholders, any action or matter expressly required by the General Corporation Law to be submitted to stockholders for approval or (ii) adopting, amending or repealing these By-laws. In addition, each committee of the Board so appointed may appoint a sub-committee of the Board in furtherance of the duties delegated to it by the Board. Each committee of the Board shall keep regular minutes of its proceedings and report the same to the Board when so requested by the Board. SECTION 3.08 Directors' Consent in Lieu of Meeting. Any action required or permitted to be taken at any meeting of the Board or of any committee thereof may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by all the members of the Board or such committee and such consent is filed with the minutes of the proceedings of the Board or such committee. SECTION 3.09 Action by Means of Telephone or Similar Communications Equipment. Any one or more members of the Board, or of any committee thereof, may participate in a meeting of the Board or such committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting by such means shall constitute presence in person at such meeting. SECTION 3.10 Compensation. Unless otherwise restricted by the Certificate of Incorporation, the Board may determine the compensation of Directors. In addition, as determined by the Board, Directors may be reimbursed by the Corporation for their expenses, if any, in the performance of their duties as By-laws of AMBAC Inc. Amended as of 1/29/97 Page 11 Directors. No such compensation or reimbursement shall preclude any Director from serving the Corporation in any other capacity and receiving compensation therefor. ARTICLE IV OFFICERS SECTION 4.01 Officers. The officers of the Corporation shall be the Chairman, the President, the Secretary and a Treasurer and may include one or more Vice Presidents and one or more Assistant Secretaries and one or more Assistant Treasurers. Any two or more offices may be held by the same person provided that the office of President and Secretary shall not be held by the same person. SECTION 4.02 Authority and Duties. All officers shall have such authority and perform such duties in the management of the Corporation as may be provided in these By-laws or, to the extent not so provided, by resolution of the Board. SECTION 4.03 Term of Office, Resignation and Removal. (a) Each officer shall be appointed by the Board and shall hold office for such term as may be determined by the Board. Each officer shall hold office until his successor has been appointed and qualified or his earlier death or resignation or removal in the manner hereinafter provided. The Board may require any officer to give security for the faithful performance of his duties. (b) Any officer may resign at any time by giving written notice to the Board, the Chairman, the President or the Secretary. Such resignation shall take effect at the time specified in such notice or, if the time be not specified, upon receipt thereof by the Board, the Chairman, the President or the Secretary, as the case may be. Unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. (c) All officers and agents appointed by the Board shall be subject to removal, with or without cause, at any time by the Board or by the action of the recordholders of a majority of the Shares entitled to vote thereon. SECTION 4.04 Vacancies. Any vacancy occurring in any office of the Corporation, for any reason, shall be filled by action of the Board. Unless By-laws of AMBAC Inc. Amended as of 1/29/97 Page 12 earlier removed pursuant to Section 4.03 hereof, any officer appointed by the Board to fill any such vacancy shall serve only until such time as the unexpired term of his predecessor expires unless reappointed by the Board. SECTION 4.05 The Chairman. The Chairman shall be the chief executive officer of the Corporation and shall have general and active management and control of the business and affairs of the Corporation, subject to the control of the Board, and shall see that all orders and resolutions of the Board are carried into effect. The Chairman shall have the power to call special meetings of Stockholders, to call special meetings of the Board and, if present, to preside at all meetings of Stockholders and all meetings of the Board. The Chairman shall perform all duties incident to the office of Chairman of the Board and all such other duties as may from time to time be assigned to him by the Board or these By-laws. SECTION 4.06 The President. The President shall be the chief operating officer of the Corporation and shall have general and active management and control the operations of the Corporation, subject to the control of the Board, and shall see that all orders and resolutions of the Board are carried into effect. The President shall perform all duties incident to the office of President and all such other duties as may from time to time be assigned to him by the Board or these By-laws. SECTION 4.07 Vice Presidents. Vice Presidents, if any, in order of their seniority or in any other order determined by the Board, shall generally assist the President and perform such other duties as the Board or the President shall prescribe, and in the absence or disability of the President, shall perform the duties and exercise the powers of the President. SECTION 4.08 The Secretary. The Secretary shall, to the extent practicable, attend all meetings of the Board and all meetings of Stockholders and shall record all votes and the minutes of all proceedings in a book to be kept for that purpose, and shall perform the same duties for any committee of the Board when so requested by such committee. He shall give or cause to be given notice of all meetings of Stockholders and of the Board, shall perform such other duties as may be prescribed by the Board, the Chairman or the President and shall act under the supervision of the Chairman. He shall keep in safe custody the seal of the Corporation and affix the same to any instrument that requires that the seal be affixed to it and which shall have been duly authorized for signature in the name of the Corporation and, when so affixed, the seal shall be attested by his signature or by the signature of the Treasurer of the Corporation (the "Treasurer") or an By-laws of AMBAC Inc. Amended as of 1/29/97 Page 13 Assistant Secretary or Assistant Treasurer of the Corporation. He shall keep in safe custody the certificate books and stockholder records and such other books and records of the Corporation as the Board, the Chairman or the President may direct and shall perform all other duties incident to the office of Secretary and such other duties as from time to time may be assigned to him by the Board, the Chairman or the President. SECTION 4.09 Assistant Secretaries. Assistant Secretaries of the Corporation ("Assistant Secretaries"), if any, in order of their seniority or in any other order determined by the Board, shall generally assist the Secretary and perform such other duties as the Board or the Secretary shall prescribe, and, in the absence or disability of the Secretary, shall perform the duties and exercise the powers of the Secretary. SECTION 4.10 The Treasurer. The Treasurer shall have the care and custody of all the funds of the Corporation and shall deposit such funds in such banks or other depositories as the Board, or any officer or officers, or any officer and agent jointly, duly authorized by the Board, shall, from time to time, direct or approve. He shall disburse the funds of the Corporation under the direction of the Board and the President. He shall keep a full and accurate account of all moneys received and paid on account of the Corporation and shall render a statement of his accounts whenever the Board, the Chairman or the President shall so request. He shall perform all other necessary actions and duties in connection with the administration of the financial affairs of the Corporation and shall generally perform all the duties usually appertaining to the office of treasurer of a corporation. When required by the Board, he shall give bonds for the faithful discharge of his duties in such sums and with such sureties as the Board shall approve. SECTION 4.11 Assistant Treasurers. Assistant Treasurers of the Corporation ("Assistant Treasurers"), if any, in order of their seniority or in any other order determined by the Board, shall generally assist the Treasurer and perform such other duties as the Board or the Treasurer shall prescribe, and, in the absence or disability of the Treasurer, shall perform the duties and exercise the powers of the Treasurer. By-laws of AMBAC Inc. Amended as of 1/29/97 Page 14 ARTICLE V CHECKS, DRAFTS, NOTES AND PROXIES SECTION 5.01 Checks, Drafts and Notes. All checks, drafts and other orders for the payment of money, notes and other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall be determined, from time to time, by resolution of the Board. SECTION 5.02 Execution of Proxies. The Chairman or the President, or, in the absence or disability of both of them, any Vice President, may authorize, from time to time, the execution and issuance of proxies to vote shares of stock or other securities of other corporations held of record by the Corporation and the execution of consents to action taken or to be taken by any such corporation. All such proxies and consents, unless otherwise authorized by the Board, shall be signed in the name of the Corporation by the Chairman, the President or any Vice President. ARTICLE VI SHARES AND TRANSFERS OF SHARES SECTION 6.01 Certificates Evidencing Shares. Shares shall be evidenced by certificates in such form or forms as shall be approved by the Board. Certificates shall be issued in consecutive order and shall be numbered in the order of their issue, and shall be signed by the Chairman, the President or any Vice President and by the Secretary, any Assistant Secretary, the Treasurer or any Assistant Treasurer; provided that if such a certificate is manually signed by one such officer, any other signature on the certificate may be a facsimile and, if such a certificate is countersigned by a transfer agent or registrar other than the Corporation or its employee, any other signature on the certificate may be a facsimile. In the event any such officer who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to hold such office or to be employed by the Corporation before such certificate is issued, such certificate may be issued by the Corporation with the same effect as if such officer had held such office on the date of issue. SECTION 6.02 Stock Ledger. A stock ledger in one or more counterparts shall be kept by the Corporation, in which shall be recorded the name and address of each person, firm or corporation owning the Shares evidenced by By-laws of AMBAC Inc. Amended as of 1/29/97 Page 15 each certificate evidencing Shares issued by the Corporation, the number of Shares evidenced by each such certificate, the date of issuance thereof and, in the case of cancellation, the date of cancellation. Except as otherwise expressly required by law, the person in whose name Shares stand on the stock ledger of the Corporation shall be deemed the owner and recordholder thereof for all purposes. The Board may from time to time appoint such transfer agents or registrars as it may deem advisable and may define their powers and duties. Any such transfer agent or registrar need not be an employee of the Corporation. SECTION 6.03 Transfers of Shares. Registration of transfers of Shares shall be made only in the stock ledger of the Corporation upon request of the registered holder of such shares, or of his attorney thereunto authorized by power of attorney duly executed and filed with the Corporation, and upon the surrender of the certificate or certificates evidencing such Shares properly endorsed or accompanied by a stock power duly executed, together with such proof of the authenticity of signatures as the Corporation may reasonably require. SECTION 6.04 Addresses of Stockholders. Each Stockholder shall designate to the Corporation an address at which notices of meetings and all other corporate notices may be served or mailed to such Stockholder, and, if any Stockholder shall fail to so designate such an address, corporate notices may be served upon such Stockholder by mail directed to the mailing address, if any, as the same appears in the stock ledger of the Corporation or at the last known mailing address of such Stockholder. SECTION 6.05 Lost, Destroyed and Mutilated Certificates. Each recordholder of Shares shall promptly notify the Corporation of any loss, destruction or mutilation of any certificate or certificates evidencing any Share or Shares of which he is the recordholder. The Board, in its discretion, or any transfer agent thereunto duly authorized by the Board, may authorize the issue of a new certificate in place of any certificate theretofore issued and alleged to have been mutilated, lost, stolen or destroyed, upon the surrender of the mutilated certificate or, in the case of loss, theft or destruction of the certificate, upon satisfactory proof of such loss, theft or destruction, and the Board may, in its discretion, require, and its transfer agents and registrars may so require, the recordholder of the Shares evidenced by the lost, stolen or destroyed certificate or his legal representative to give the Corporation a bond sufficient to indemnify the Corporation against any claim made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate. By-laws of AMBAC Inc. Amended as of 1/29/97 Page 16 SECTION 6.06 Regulations. The Board may make such other rules and regulations as it may deem expedient, not inconsistent with these By-laws, concerning the issue, transfer and registration of certificates evidencing Shares. SECTION 6.07 Fixing Date for Determination of Stockholders of Record. In order that the Corporation may determine the Stockholders entitled to notice of or to vote at any meeting of Stockholders or any adjournment thereof, or to express consent to, or to dissent from, corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board may fix, in advance, a record date, which shall not be more than 60 nor less than 10 days before the date of such meeting, nor more than 60 days prior to any other such action. A determination of the Stockholders entitled to notice of or to vote at a meeting of Stockholders shall apply to any adjournment of such meeting; provided, however, that the Board may fix a new record date for the adjourned meeting. ARTICLE VII SEAL SECTION 7.01 Seal. The Board may approve and adopt a corporate seal, which shall be in the form of a circle and shall bear the full name of the Corporation, the year of its incorporation and the words "Corporate Seal Delaware". ARTICLE VIII FISCAL YEAR SECTION 8.01 Fiscal Year. The fiscal year of the Corporation shall end on the thirty-first day of December of each year unless changed by resolution of the Board. By-laws of AMBAC Inc. Amended as of 1/29/97 Page 17 ARTICLE IX INDEMNIFICATION AND INSURANCE SECTION 9.01 Indemnification. (a) The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. (b) The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. By-laws of AMBAC Inc. Amended as of 1/29/97 Page 18 (c) To the extent that a director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 9.01(a) and (b) of these By-laws, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. (d) Any indemnification under Section 9.01(a) and (b) of these By-laws (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Section 9.01(a) and (b) of these By-laws. Such determination shall be made (i) by the Board by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (ii) if such a quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (iii) by the stockholders of the Corporation. (e) Expenses (including attorneys' fees) incurred by an officer or director in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation pursuant to this Article IX. Such expenses (including attorneys' fees) incurred by other employees and agents may be so paid upon such terms and conditions, if any, as the Board deems appropriate. (f) The indemnification and advancement of expenses provided by, or granted pursuant to, other Sections of this Article IX shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any law, by-law, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office. (g) For purposes of this Article IX, references to "the Corporation" shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, employees or agents so that any By-laws of AMBAC Inc. Amended as of 1/29/97 Page 19 person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Article IX with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued. (h) For purposes of this Article IX, references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to "serving at the request of the Corporation" shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves service by, such director, officer, employee or agent with respect to any employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Article IX. (i) The indemnification and advancement of expenses provided by, or granted pursuant to, this Article IX shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. SECTION 9.02 Insurance for Indemnification. The Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of Section 145 of the General Corporation Law. By-laws of AMBAC Inc. Amended as of 1/29/97 Page 20 ARTICLE X AMENDMENTS SECTION 10.01 Amendments. Any By-law (including these By-laws) may be adopted, amended or repealed by the vote of the recordholders of a majority of the Shares then entitled to vote at an election of Directors or by written consent of Stockholders pursuant to Section 2.09 hereof, or by vote of the Board or by a written consent of Directors pursuant to Section 3.08 hereof. EX-10.01B 3 AMDNT. TO AMENDED & RESTATE EMPLOYMENT AGRMT EXHIBIT 10.01(b) AMENDMENT TO EMPLOYMENT AGREEMENT AMENDMENT, DATED AS OF JANUARY 29, 1997, TO THE EMPLOYMENT AGREEMENT, DATED AS OF JULY 18, 1991, AND AS AMENDED AND RESTATED IN FULL AS OF DECEMBER 30, 1994 (AS SO AMENDED AND RESTATED, THE "AGREEMENT"), BY AND BETWEEN AMBAC INC., A DELAWARE CORPORATION (THE "COMPANY"), AND PHILLIP B. LASSITER (THE "EXECUTIVE"). WHEREAS, the Company and the Executive entered into the original version of the Agreement as of July 18, 1991, in order to provide for the Executive to be employed by the Company as its Chairman and Chief Executive Officer upon the terms and conditions set forth in such original version, the Executive's responsibilities subsequently having been enlarged to include President of the Company; and WHEREAS, the Company and the Executive agreed to certain amendments to the original version of the Agreement and entered into the amended and restated version of the Agreement as of December 30, 1994; and WHEREAS, the Company and the Executive now wish to amend the Agreement in the manner set forth herein, such amendments having been approved by the Compensation and Organization Committee of the Company's Board of Directors; NOW, THEREFORE, in consideration of the foregoing premises and of the covenants and agreements herein contained, the parties hereto agree as follows (all capitalized terms used herein without definition having the meanings ascribed thereto in the Agreement): 1. DEFINITION OF CHANGE IN CONTROL. SECTION 10(C) OF THE AGREEMENT IS AMENDED IN ITS ENTIRETY TO READ AS FOLLOWS: "For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the date on which one of the following events occurs: (i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended) of 20% or more of the common stock of the Company, par value $0.01 per share (the "COMMON STOCK"), THEN OUTSTANDING, BUT SHALL NOT INCLUDE ANY SUCH ACQUISITION BY: (A) the Company; (B) any Subsidiary of the Company; (C) any employee benefit plan of the Company or of any Subsidiary of the Company; (D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan; (E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common Stock outstanding on such date unless and until such Person, together with all affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common Stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or (F) any Person who becomes the Beneficial Owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred; or (ii) individuals who, as of January 29, 1997, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board. As used herein, "Person" means any individual, firm, corporation, partnership or other entity, and "Subsidiary" means (i) a corporation or other entity with respect to which the Company, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to elect at least a majority of the members of such corporation's board of directors or analogous governing body, or (ii) any other corporation or other entity in which the Company, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of this Agreement." 2. AGREEMENT REMAINS IN FORCE. Except as modified by this Amendment, the Agreement remains in full force and effect in accordance with the terms thereof. IN WITNESS WHEREOF the parties hereto have executed this Amendment as of the day and year first written above. AMBAC INC. By:/s/ Richard B. Gross -------------------- Richard B. Gross Senior Vice President, General Counsel and Secretary /s/ Phillip B. Lassiter ----------------------- Phillip B. Lassiter 16 Sutton Place - 12A New York, NY 10022 EX-10.02 4 AMBAC INC. 1991 STOCK INCENTIVE PLAN (AS AMENDED) EXHIBIT 10.02 AMBAC INC. 1991 STOCK INCENTIVE PLAN AS AMENDED THROUGH JANUARY 29, 1997 1. DEFINITIONS (a) "Agreement" means an agreement between the Company and a Participant setting forth the terms and conditions of an Award. (b) "Award" means a stock option (including an incentive stock option under Section 422 of the Code), stock appreciation right, performance unit award, restricted stock award or other stock or stock-based award, or any combination of them, as described in and granted under the Plan. (c) "Board" means the Board of Directors of the Company. (d) "Change in Control" means (i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of the Common Stock then outstanding, but shall not include any such acquisition by: (A) the Company; (B) any Subsidiary of the Company; (C) any employee benefit plan of the Company or of any Subsidiary of the Company; (D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan; (E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common Stock outstanding on such date unless and until such Person, together with all affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common Stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or (F) any Person who becomes the Beneficial Owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such 1 2 Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred; or (ii) individuals who, as of January 29, 1997, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board. (e) "Code" means the Internal Revenue Code of 1986, as amended. (f) "Committee" means the committee referred to in Section 3(a) of the Plan. (g) "Common Stock" means the Common Stock of the Company, par value $.01 per share, or such other class or kind of share or other securities as may be applicable under Section 12. (h) "Company" means AMBAC Inc., a Delaware corporation, or any successor to substantially all its business. (i) "Employee" means an officer or other employee of the Company or a Related Company. (j) "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations thereunder. (k) "Exchange Act" means the Securities and Exchange Act of 1934, as amended, and the rules and regulations thereunder. (l) "Fair Market Value" means the average of the highest and the lowest quoted selling price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or, in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case on the valuation date (or, if there were no sales on the valuation date, the average of 3 the highest and the lowest quoted selling prices as reported on said composite tape or automated quotation system for the most recent day during which a sale occurred). (m) "Incentive Stock Option" means a stock option that is intended to comply with the requirements of Section 422 of the Code or any successor provision thereto. (n) "Participant" means an Employee who has been granted an Award under the Plan. (o) "Person" means any individual, firm, corporation, partnership or other entity. (p) "Plan" means the 1991 Stock Incentive Plan of the Company as described herein. (q) "Related Company" means any corporation or other entity in which the Company has or obtains a proprietary interest by reason of stock ownership or otherwise. (r) "Subsidiary" means (i) a corporation or other entity with respect to which the Company, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to elect at least a majority of the members of such corporation's board of directors or analogous governing body, or (ii) any other corporation or other entity in which the Company, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of the Plan. 2. PURPOSE The Plan is intended to provide an incentive to selected Employees of the Company and of its Related Companies to remain in the employ of the Company and its Related Companies and to increase their interest in the success of the Company by providing them with opportunities to increase their proprietary interest in the Company and to receive compensation based upon the Company's success. 3. ADMINISTRATION (a) A committee (the "COMMITTEE") appointed by the Board shall be responsible for administering the Plan. The Committee shall be comprised of two or more members of the Board who qualify as "disinterested persons" as contemplated by Rule 16b-3 promulgated under the Exchange Act, or any successor provision thereto. (b) The Committee shall have authority to adopt such rules as it may deem appropriate to carry out the purposes of the Plan, and shall have authority to interpret and construe the provisions of the Plan and any agreements under the Plan and to make determinations pursuant to any Plan provision or agreement. Each interpretation, determination or other action made or taken 4 by the Committee pursuant to the Plan shall be final and binding on all persons. No member of the Committee shall be liable for any action or determination made in good faith, and the members of the Committee shall be entitled to indemnification and reimbursement in the manner provided in the Company's Certificate of Incorporation as it may be amended from time to time. (c) The Committee may designate persons other than its members to carry out its responsibilities under such conditions or limitations as it may set, except that the Committee may not delegate (i) its authority with regard to Awards (including decisions concerning the timing, pricing and amount of Awards) granted to Employees who are officers or directors for purposes of Section 16(b) of the Exchange Act or (ii) its authority pursuant to Section 10 to amend the Plan. 4. ELIGIBILITY Awards may be granted only to Employees. The Committee shall have the authority to select the Participants to whom Awards may be granted and to determine the number and form of Awards to be granted to each Participant. 5. STOCK SUBJECT TO THE PROVISIONS OF THE PLAN (a) Subject to adjustment in accordance with the provisions of Section 12, and subject to Sections 5(c) and 5(d) below, the total number of shares of Common Stock available for Awards under the Plan shall be: (i) 1,500,000, plus (ii) for each calendar year, starting with 1993, during any part of which the Plan is in effect, a number of shares (hereinafter referred to as the "Annual Limit" for such year) equal to 1.3% of the total number of shares of Common Stock outstanding on a fully diluted basis as of the immediately preceding December 31, provided, however, that at no time may any Award be made that would cause the cumulative number of shares of Common Stock subject to Award made under the Plan since its inception to exceed 10% of the number of shares of Common Stock outstanding on a fully diluted basis as of the last day of the most recently completed fiscal quarter of the Company. Any unused portion of the Annual Limit for any calendar year shall be carried forward and shall be available for Awards in future years. Any shares issued under the Plan may consist, in whole or in part, of authorized but unissued Common Stock or of treasury stock. (b) For purposes of computing the number of shares Common Stock remaining available for Awards at any time, there shall be debited against the total number of shares determined to be available pursuant to Section 5(a) and 5(c) (i) the number of shares of Common 5 Stock issuable upon exercise of stock options granted pursuant to Section 6, (ii) the number of shares of restricted stock awarded pursuant to Section 6 and (iii) the maximum number of shares of Common Stock that may be issued under performance unit Awards or other stock or stock-based Awards granted pursuant to Section 6. In the case of a stock option granted in tandem with a stock appreciation right, the exercise of the option or stock appreciation right will reduce proportionately the number of shares subject to the tandem stock appreciation right or option, as the case may be. Any shares ceasing to be subject to the tandem option or right because of such reduction shall not be available for future Awards granted under the Plan. (c) Any shares represented by Awards which are forfeited, terminated, paid in cash or expire unexercised, any shares which have been exchanged by a Participant or withheld by the Company as full or partial payment to the Company in connection with any Award (including in connection with the payment of any taxes related to such Award), and the excess amount of variable Awards which become fixed at less than their maximum limitations (including as such any Awards denominated in a specified number of shares of Common Stock that are settled by issuance of a lesser number of shares), shall again be available for grants and issuance under the Plan, provided, however, that the Committee may limit the application of this Section 5(c) in any manner that it considers necessary or appropriate to ensure that the Plan complies with the requirements of Rule 16b-3 under the Exchange Act or any successor provision. (d) At no time may any Award be made that would cause the cumulative number of shares of Common Stock (and of units denominated in Common Stock) granted to Participants under the Plan for no consideration other than the provision of services, or sold for consideration in cash, other property or a combination of cash and other property the aggregate value of which (as determined by the Committee) is less than the Fair Market Value of such shares, since the inception of the Plan to exceed 4% of the total number of shares of Common Stock outstanding on a fully diluted basis as of the last day of the most recently completed fiscal quarter of the Company, provided, however, that any such shares or units that are granted in lieu of cash compensation that otherwise would be paid to a Participant, or that are granted in satisfaction of any other obligation owed by the Company or a Related Company (including without limitation obligations under the former AMBAC Indemnity Corporation Long-Term Incentive Plan) to a Participant (other than an obligation to a newly hired employee), shall not be counted against such limitation. 6 6. AWARDS UNDER THE PLAN (a) Restricted Stock (i) General. Subject to Section 5(d), shares of Common Stock may be granted to a Participant for no consideration other than the provision of services or may be offered for sale to a Participant at a purchase price determined by the Committee. Such shares of Common Stock shall be subject to such restrictions on transfer or other incidents of ownership for such periods of time, and shall be subject to such conditions of vesting, as the Committee may determine and as shall be set forth in the Agreement relating to such stock. (Shares subject to such restrictions are referred to herein as "Restricted Shares.") If shares of Common Stock are offered for sale under the Plan, the purchase price shall be payable in cash, or, in the sole discretion of the Committee and to the extent provided in any applicable Agreement, in shares of Common Stock already owned by the Participant, for other consideration acceptable to the Committee or in any combination of cash, shares of Common Stock or such other consideration. (ii) Share Certificates; Rights and Privileges. At the time Restricted Shares are granted or sold to a Participant, share certificates representing the appropriate number of Restricted Shares shall be registered in the name of the Participant but shall be held by the Company in custody for the account of such person. The certificates shall bear a legend restricting their transferability as provided herein. Except for such restrictions on transfer or other incidents of ownership as may be determined by the Committee and set forth in the Agreement relating to an award or sale of Restricted Shares, a Participant shall have the rights of a stockholder as to such Restricted Shares, including the right to receive dividends and the right to vote in accordance with the Company's Restated Certificate of Incorporation. (iii) Distributions. Any shares of Common Stock or other securities of the Company received by a Participant to whom Restricted Shares have been granted or sold as a result of a stock distribution to holders of Common Stock or as a stock dividend on Common Stock shall be subject to the same terms, conditions and restrictions as such Restricted Shares. 7 (b) Stock Options (i) General. A stock option shall entitle the Participant to whom the option is granted to purchase a specified number of shares of Common Stock during a specified time at an exercise price that is fixed at the time of grant or for which the method of determining the exercise price is specified at the time of grant, all as the Committee may determine. With respect to any stock option granted on or after March 3, 1993, the per share exercise price of any stock options whose price is fixed at the time of grant shall not be less than the Fair Market Value of a share of Common Stock as of the date of grant, and the per share exercise price of any stock option whose price is not fixed at the time of grant but for which the method of determining the exercise price is specified at the time of grant shall be not less than the Fair Market Value of a share of Common Stock as of the date on which such exercise price is so determined. Payment of the exercise price shall be made in cash, or, to the extent provided in the Agreement relating to the option, in shares of Common Stock (including shares already owned by the Participant or to be issued to the Participant upon exercise of the option) or in any combination of cash and shares of Common Stock. The Agreement relating to a stock option shall set forth the applicable vesting schedule. A stock option shall be effective for such term as shall be determined by the Committee and set forth in the Agreement relating to such option. (ii) Incentive Stock Options. Each stock option granted pursuant to the Plan shall be designated at the time of grant as either an Incentive Stock Option (or shall otherwise be designated as an option entitled to favorable treatment under the Code) or as a "nonqualified stock option." The aggregate fair market value (within the meaning of the Code and determined at the time of grant of the Award) of the stock with respect to which Incentive Stock Options are exercisable for the first time by a Participant during a calendar year shall not exceed $100,000, or such other limit as may from time to time be established under the Code. No Incentive Stock Option may be issued pursuant to the Plan to any individual who, at the time the option is granted, owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or any of its subsidiaries, unless (A) the exercise price determined as of the date of grant is at least 110% of the Fair Market Value on the date of grant of the shares of Common Stock subject to such option, and (B) the Incentive Stock Option is not exercisable more than five years from the date of grant thereof. (c) Stock Appreciation Rights (i) General. A stock appreciation right shall entitle a Participant to receive, upon exercise, (x) an amount in cash equal to the excess, if any, of the Fair Market Value on the exercise date of the number of shares of Common Stock for which the stock appreciation right is exercised, over the Fair Market Value of such number of shares on the 8 date of grant (or, in the case of a stock appreciation right granted in tandem with a stock option, the aggregate exercise price which the Participant would otherwise have been required to pay under the terms of the stock option in order to purchase such shares), or (y) a number of shares of Common Stock having an aggregate Fair Market Value, as of the date of exercise, equal to the amount determined as in the preceding clause (x), or (z) a combination of cash and shares having an aggregate value equal to the amount determined as in the preceding clause (x). (ii) Exercisability. The Committee shall determine whether payments in respect of a stock appreciation right shall be in cash, shares of Common Stock or a combination thereof. A stock appreciation right shall be exercisable at the time or times established by the Committee at the time of grant. If a stock appreciation right is granted in tandem with a stock option, the stock appreciation right shall not be exercisable prior to or later than the time the related stock option could be exercised. (d) Performance Units. Performance units may be granted as fixed or variable share-or dollar-denominated units subject to such conditions of vesting and time of payment as the Committee may determine and as shall be set forth in the Agreement relating to such performance units. Performance units may be paid in Common Stock, cash or a combination of Common Stock and cash, as the Committee may determine. (e) Other Stock or Stock-Based Awards. An Award other than as described in subsections (a) through (d) above may be granted pursuant to which Common Stock is or in the future may be acquired, or which is valued or determined in whole or part by reference to, or otherwise based upon, Common Stock. (f) General Terms. The following terms and conditions shall be applicable to Awards: (i) Dividend Equivalents. The Committee may provide Participants with the right to receive payments equivalent to dividends or interest with respect to an outstanding Award, which payments can either be paid currently or deemed to have been reinvested in shares of Common Stock. Payment of such amounts can be made in Common Stock, cash or a combination of Common Stock and cash, as the Committee shall determine. (ii) Transfers. Unless the Committee determines otherwise, no Award shall be transferable other than by will or by the laws of descent and distribution or pursuant to a domestic relations order; provided, however, that the Committee may, in its discretion and subject to such terms and conditions as it shall specify, permit the transfer of an Award for no consideration to a Participant's family members or to one or more trusts or partnerships established in whole or in part for the benefit of one or more of such family members (collectively, "PERMITTED TRANSFEREES"). Any Award transferred to a Permitted Transferee 9 shall be further transferable only by will or the laws of descent and distribution or, for no consideration, to another Permitted Transferee of the Participant. The Committee may in its discretion permit transfers of Awards other than those contemplated by this Section. (iii) Award Exercisable Only by Participant and Permitted Transferees. During the lifetime of a Participant, a stock option, stock appreciation right or other Award providing for exercise shall be exercisable only by the Participant or by a Permitted Transferee to whom such stock option, stock appreciation right or other Award has been transferred in accordance with Section 6(f)(ii). The grant of an Award shall impose no obligation on a Participant to exercise the Award. (iv) Rights of a Stockholder. A Participant shall have no rights as a stockholder with respect to shares covered by an Award until the date the Participant or his nominee becomes the holder of record of such shares. No adjustment will be made for dividends or other rights for which the record date is prior to such date, except as provided in Section 12. (v) Limitation on Exercise. An Award may not be exercised, and no shares of Common Stock may be issued in connection with an Award, unless the issuance of such shares has been registered under the Securities Act of 1933, as amended, and qualified under applicable state "blue sky" laws, or the Company has determined that an exemption from registration and from qualification under such state "blue sky" laws is available. (vi) Single or Tandem Grants. Any Award described in subsections (a) through (e) above may be granted singly or in combination or tandem with any other Award, as the Committee may determine. Awards may be made in combination with, in replacement of or as alternatives to grants or rights under any other employee or compensation plan of the Company, including the plan of any acquired entity. 7. AGREEMENTS The terms and conditions of each Award shall be embodied in an Agreement in a form approved by the Committee, which shall contain terms and conditions not inconsistent with the Plan and which shall incorporate the Plan by reference. 10 8. TERMINATION OF EMPLOYMENT The Agreement relating to an Award will set forth provisions governing the disposition of an Award in the event of the retirement, disability, death or other termination of a Participant's employment. 9. TAX WITHHOLDING The Company or a subsidiary thereof, as appropriate, may require any individual entitled to receive a payment in respect of an Award to remit to the Company, prior to such payment, an amount sufficient to satisfy any Federal, state or local tax withholding requirements. The Company or a subsidiary thereof, as appropriate, shall also have the right to deduct from all cash payments made pursuant to or in connection with any Award any Federal, state or local taxes required to be withheld with respect to such payments. In addition, the Company may permit any individual to whom an Award has been made to satisfy, in whole or in part, such obligation to remit taxes, by directing the Company to withhold shares of Common Stock that would otherwise be received by such individual upon settlement or exercise of such Award, pursuant to such rules as the Committee may establish from time to time. 10. AMENDMENTS The Committee may at any time and from time to time alter, amend, suspend or terminate the Plan in whole or in part, provided, however, that any amendment which under the requirements of applicable law must be approved by the stockholders of the Company shall not be effective unless and until such stockholder approval has been obtained in compliance with such law, and provided, further, that any amendment that must be approved by the stockholders of the Company in order to maintain the continued qualification of the Plan under Rule 16b-3 under the Exchange Act, or any successor provision, shall not be effective unless and until such stockholder approval has been obtained in compliance with such rule. No termination or amendment of the Plan may, without the consent of the Participant to whom an Award has been granted, adversely affect the rights of such Participant under such Award. 11. APPLICATION OF FUNDS The proceeds received by the Company from the sale of Common Stock or other securities pursuant to Awards will be used for general corporate purposes. 11 12. ADJUSTMENT OF AND CHANGES IN SHARES In the event of any merger, consolidation, recapitalization, reclassification, stock dividend, distribution of property, special cash dividend, or other change in corporate structure affecting the shares, the Committee shall make such adjustments, if any, as it deems appropriate in the number and class of shares subject to, and the exercise price of, outstanding options granted under the Plan, and in the value of, or number or class of shares subject to, other Awards granted or available to be granted under the Plan. The foregoing adjustments shall be determined by the Committee in its sole discretion. 13. NO RIGHT TO EMPLOYMENT No person shall have any claim or right to receive grants of Awards under the Plan. Neither the Plan, the grant of Awards under the Plan, nor any action taken or omitted to be taken under the Plan shall be deemed to create or confer on any employee any right to be retained in the employ of the Company or any subsidiary or other affiliate thereof, or to interfere with or to limit in any way the right of the Company or any subsidiary or other affiliate thereof to terminate the employment of such employee at any time. 14. CHANGE IN CONTROL In order to maintain the Participants' rights in the event of a Change in Control, the Committee, in its sole discretion, may, either at the time an Award is made hereunder or at any time prior to, or coincident with or after the time of a Change in Control: (i) provide for the acceleration of any time periods relating to the exercise or realization of such Awards so that such Awards may be exercised or realized in full on or before a date fixed by the Committee; (ii) provide for the purchase of such Awards, upon the Participant's request, for an amount of cash equal to the amount which could have been obtained upon the exercise or realization of such rights had such Awards been currently exercisable or payable; (iii) make such adjustments to the Awards then outstanding as the Committee deems appropriate to reflect such Change in Control; or (iv) cause the Awards then outstanding to be assumed, or new rights substituted therefor, by the surviving corporation in such Change in Control. 12 The Committee may, in its discretion, include such further provisions and limitations in any agreement documenting such Awards as it may deem equitable and in the best interests of the Company in the event of a Change in Control, except that in no event may the Committee take actions that would cause the Plan to lose qualification under Rule 16b-3 under the Exchange Act, or take actions that will enable any Participant to incur liability under Section 16(b) of the Exchange Act. 15. GOVERNING LAW The Plan and all agreements entered into under the Plan shall be construed in accordance with and governed by the laws of the state of Delaware. 16. EFFECTIVE DATE The effective date of this Plan shall be the date of the consummation of the "Equity Offerings", as such term is defined in the Company's Registration Statement No. 33-40306 on Form S-1. 17. TERM OF THE PLAN Unless earlier terminated pursuant to Section 10, the Plan shall terminate on the tenth anniversary of the effective date provided for in Section 16, except with respect to Awards then outstanding. 18. NO RESTRICTION ON RIGHT OF COMPANY TO EFFECT CORPORATE CHANGES The Plan shall not affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalization, reorganizations or other changes in the Company's capital structure or its business, or any merger or consolidation of the Company, or any issue of stock or of options, warrants or rights to purchase stock or of bonds, debentures, preferred or prior preference stocks whose rights are superior to or affect the Common Stock or the rights thereof or which are convertible into or exchangeable for Common Stock, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise. 13 19. EXCHANGE ACT Notwithstanding anything contained in the Plan or any agreement under the Plan to the contrary, if the consummation of any transaction under the Plan, or the taking of any action by the Committee in connection with a Change in Control, would result in the possible imposition of liability on a Participant pursuant to Section 16(b) of the Exchange Act, the Committee shall have the right, in its sole discretion, but shall not be obligated, to defer such transaction or the effectiveness of such action to the extent necessary to avoid such liability, but in no event for a period longer than 180 days. EX-10.06B 5 FORM OF AMDNT TO MANAGEMENT RETENTION AGREEMENT EXHIBIT 10.06(b) FORM OF AMENDMENT NO. 1 TO MANAGEMENT RETENTION AGREEMENT AMENDMENT NO. 1, DATED AS OF JANUARY 29, 1997, TO THE MANAGEMENT RETENTION AGREEMENT, MADE AS OF DECEMBER 30, 1994 (THE "AGREEMENT"), BY AND BETWEEN AMBAC INC., A DELAWARE CORPORATION (THE "COMPANY"), AND THE OFFICER NAMED ON THE SIGNATURE PAGE OF THIS AMENDMENT NO. 1 (THE "EXECUTIVE"). WHEREAS, the Company and the Executive entered into the Agreement in order to further the Company's policy of fostering the continuous employment of key management personnel, such as the Executive, in the event of any actual or threatened change in control by providing for the payment of severance and other benefits in the event of the Executive's termination of employment following a change in control; and WHEREAS, the Company and the Executive have agreed to amend the Agreement in the manner set forth herein, such amendments having been approved by the Compensation and Organization Committee of the Company's Board of Directors; NOW, THEREFORE, in consideration of the foregoing premises and of the covenants and agreements herein contained, the parties hereto agree as follows (all capitalized terms used herein without definition having the meanings ascribed thereto in the Agreement): 1. DEFINITION OF CHANGE IN CONTROL. (a) Addition of Cross-Reference. The first sentence of Section 2 of the Agreement is amended by adding the expression "(as defined in Section 7(i) of this Agreement)" immediately following the words "on the date of any Change in Control" occurring in such sentence. (b) Elimination of Old Definition. The third sentence of Section 2 of the Agreement, which sets forth the definition of "Change in Control" currently applicable to the Agreement, is eliminated in its entirety. (b) Addition of New Definition. A new Section 7(i) is added to the Agreement as follows: "(i) CHANGE IN CONTROL. For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the date on which one of the following events occurs: (i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended) of 20% or more of the common stock of the Company, par value $0.01 per share (the "COMMON STOCK"), then outstanding, but shall not include any such acquisition by: (A) the Company; (B) any Subsidiary of the Company; (C) any employee benefit plan of the Company or of any Subsidiary of the Company; (D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan; (E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common Stock outstanding on such date unless and until such Person, together with all Affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common Stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or (F) any Person who becomes the Beneficial Owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred; or (ii) individuals who, as of January 29, 1997, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board. As used herein, "Person" means any individual, firm, corporation, partnership or other entity, and "Subsidiary" means (i) a corporation or other entity with respect to which the Company, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to elect at least a majority of the members of such corporation's board of directors or analogous governing body, or (ii) any other corporation or other entity in which the Company, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of this Agreement." 2. AGREEMENT REMAINS IN FORCE. Except as modified by this Amendment no. 1, the Agreement remains in full force and effect in accordance with the original terms thereof. IN WITNESS WHEREOF the parties hereto have executed this Amendment No. 1 as of the day and year first written above. AMBAC INC. By: ---------------------------- ----------------------------------- Name: Name: Title: Address: EX-10.16 6 AMDNT NO. 3 TO THE DEUTSCHE BK CREDIT AGREEMENT EXHIBIT 10.16 AMENDMENT NO. 3 TO CREDIT AGREEMENT ----------------------------------- AMENDMENT NO. 3 TO CREDIT AGREEMENT (this "Amendment") dated as of December 2, 1996 among AMBAC Indemnity Corporation (the "Borrower"), Deutsche Bank AG, New York Branch ("Deutsche Bank"), Landesbank Hessen-Thuringen Girozentrale, ("Helaba"), Bayerische Landesbank Girozentrale, ("BLG"), Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland", New York Branch ("Rabobank" and, together with Helaba and BLG, the "New Banks"), and Deutsche Bank AG, New York Branch, as Agent (the "Agent"). W I T N E S S E T H : - - - - - - - - - - WHEREAS, the Borrower, Deutsche Bank and the Agent have entered into a Credit Agreement, dated as of December 2, 1993 (as amended to date, the "Agreement"); and WHEREAS, each of the New Banks desire to become, and the Borrower, Deutsche Bank and the Agent desire that the New Banks become, Banks pursuant to and for purposes of the Agreement; and WHEREAS, the parties hereto desire to amend the Agreement as herein provided; and WHEREAS, pursuant to Section 12.12 of the Agreement, the Agreement may be amended by the written agreement of the Borrower, the Banks and the Agent; NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not ------------- otherwise defined herein shall have the meanings assigned to such terms in the Agreement. 2. Amendments. (a) The "December 2, 2002" date set forth in ---------- the first sentence of Section 3.04 is hereby amended to "December 2, 2003". (b) Schedule I is hereby deleted in its entirety and replaced with Exhibit A attached hereto. 3. No Default. The Borrower hereby represents and warrants to ---------- the Banks and the Agent that, both before and after giving effect to this Amendment, no Default or Event of Default exists. 4. Representations and Warranties. The Borrower hereby ------------------------------ represents and warrants to the Banks and the Agent that, both before and after giving effect to this Amendment, the representations and warranties contained in Section 7 of the Agreement are true and correct in all material respects on and as of the date hereof. 5. Counterparts. This Amendment may be executed simultaneously ------------ in two or more counterparts, each of which shall be deemed to be an original, and it shall not be necessary in making proof of this Amendment to produce or account for more than one such counterpart. 6. Agreement Not Otherwise Amended. Terms and provisions of ------------------------------- the Agreement not amended hereby shall continue to remain in full force and effect. From and after the date hereof, all references in the Agreement and each of the Credit Documents to the Agreement shall be deemed references to the Agreement as amended by this Amendment. 7. GOVERNING LAW. THIS AMENDMENT AND THE RIGHTS AND ------------- OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF NEW YORK. IN WITNESS WHEREOF, each of the parties hereto has caused this Amendment to be executed and delivered on its behalf, all on the date first above written. AMBAC INDEMNITY CORPORATION By /s/ Frank Bivona ------------------------------ Title: SVP, CFO & Treas. -2- DEUTSCHE BANK AG, NEW YORK BRANCH, Individually and as Agent By /s/ Eckhard Osenberg ------------------------------ Title: AVP By /s/ Louis Caltavuturo ------------------------------ Title: AVP Address: LANDESBANK HESSEN-THURINGEN 420 Fifth Avenue GIROZENTRALE 24th Floor New York, New York 10018 Attention: Mr. Richard Skierra By /s/ Lisa S. Pent ---------------- Title: SVP, Manager By /s/ Richard E. Skiera --------------------- Title: AVP BAYERISCHE LANDESBANK 560 Lexington Avenue GIROZENTRALE 22nd Floor New York, New York 10022 Attention: Mr. Scott Allison By /s/ Peter Obermann ------------------ Title: SVP By /s/ Wilfried Freudenberger -------------------------- Title: EVP COOPERATIEVE CENTRALE 245 Park Avenue RAIFFEISEN-BOERENLEENBANK New York, New York 10167 B.A.,"RABOBANK NEDERLAND", Attention: Corporate Services NEW YORK BRANCH Department By /s/ Ian Reece ------------- Title: VP & Manager By /s/ Angela R. Reilly -------------------- Title: VP -3- EXHIBIT A --------- SCHEDULE I ---------- COMMITMENTS ----------- BANK COMMITMENT AMOUNT ---- ----------------- DEUTSCHE BANK AG, NEW YORK BRANCH $213,000,000 LANDESBANK HESSEN-THURINGEN GIROZENTRALE 35,000,000 BAYERISCHE LANDESBANK GIROZENTRALE 30,000,000 COOPERATIEVE CENTRALE RAIFFEISEN- 72,000,000 BOERENLEENBANK B.A., "RABOBANK NEDERLAND", NEW YORK BRANCH --------------- TOTAL $350,000,000 ============ EX-10.17 7 AMDNT NO. 4 TO THE DEUTSCHE BK CREDIT AGREEMENT EXHIBIT 10.17 AMENDMENT NO. 4 TO CREDIT AGREEMENT ----------------------------------- AMENDMENT NO. 4 TO CREDIT AGREEMENT (this "Amendment") dated as of February 14, 1997 among AMBAC Indemnity Corporation (the "Borrower"), Deutsche Bank AG, New York Branch ("Deutsche Bank"), Landesbank Hessen-Thuringen Girozentrale, ("Helaba"), Bayerische Landesbank Girozentrale, ("BLG"), Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland", New York Branch ("Rabobank" and, together with Deutsche Bank, Helaba and BLG, the "Banks"), and Deutsche Bank AG, New York Branch, as Agent (the "Agent"). W I T N E S S E T H : - - - - - - - - - - WHEREAS, the Borrower, the Banks and the Agent have entered into a Credit Agreement, dated as of December 2, 1993 (as amended to date, the "Agreement"); and WHEREAS, Deutsche Bank desires to be removed as a Bank, and transfer all of its interest in the Agreement to the Helaba, BLG and Rabobank; and WHEREAS, Helaba, BLG and Rabobank are willing to accept a transfer of Deutsche Bank's interest in the Agreement by amendment to the Agreement as herein provided; and WHEREAS, pursuant to Section 12.12 of the Agreement, the Agreement may be amended by the written agreement of the Borrower, the Banks and the Agent; NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto hereby agree as follows: 1. Defined Terms. Capitalized terms used herein and not ------------- otherwise defined herein shall have the meanings assigned to such terms in the Agreement. 2. Amendment. Schedule I is hereby deleted in its entirety and --------- replaced with Exhibit A attached hereto. 3. No Default. The Borrower hereby represents and warrants to ---------- the Banks and the Agent that, both before and after giving effect to this Amendment, no Default or Event of Default exists. 4. Representations and Warranties. The Borrower hereby ------------------------------ represents and warrants to the Banks and the Agent that, both before and after giving effect to this Amendment, the representations and warranties contained in Section 7 of the Agreement are true and correct in all material respects on and as of the date hereof. 5. Counterparts. This Amendment may be executed simultaneously ------------ in two or more counterparts, each of which shall be deemed to be an original, and it shall not be necessary in making proof of this Amendment to produce or account for more than one such counterpart. 6. Agreement Not Otherwise Amended. Terms and provisions of ------------------------------- the Agreement not amended hereby shall continue to remain in full force and effect. From and after the date hereof, all references in the Agreement and each of the Credit Documents to the Agreement shall be deemed references to the Agreement as amended by this Amendment. 7. GOVERNING LAW. THIS AMENDMENT AND THE RIGHTS AND ------------- OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF NEW YORK. IN WITNESS WHEREOF, each of the parties hereto has caused this Amendment to be executed and delivered on its behalf, all on the date first above written. AMBAC INDEMNITY CORPORATION By /s/ Phillip Lassiter -------------------------------- Title: Chairman, Pres. & CEO -2- DEUTSCHE BANK AG, NEW YORK BRANCH, Individually and as Agent By /s/ Eckhard Osenberg -------------------------------- Title: AVP By /s/ Louis Caltavuturo -------------------------------- Title: AVP LANDESBANK HESSEN-THURINGEN GIROZENTRALE By /s/ Lisa S. Pent ------------------- Title: SVP & Manager By /s/ Richard E. Skiera ------------------------ Title: AVP BAYERISCHE LANDESBANK GIROZENTRALE By /s/Wilfried Freudenberger ---------------------------- Title: EVP & Gen. Manager By /s/ Peter Obermann --------------------- Title:SVP, Man. Lend. Div. COOPERATIEVE CENTRALE RAIFFEISEN-BOERENLEENBANK B.A.,"RABOBANK NEDERLAND", NEW YORK BRANCH By /s/ Ian Reece ---------------- Title: VP & Manager By /s/ Angela R. Reilly ----------------------- Title: VP -3- EXHIBIT A --------- SCHEDULE I ---------- COMMITMENTS ----------- BANK COMMITMENT AMOUNT ---- ----------------- LANDESBANK HESSEN-THURINGEN GIROZENTRALE $ 82,000,000 BAYERISCHE LANDESBANK GIROZENTRALE 81,000,000 COOPERATIEVE CENTRALE RAIFFEISEN- 187,000,000 BOERENLEENBANK B.A., "RABOBANK NEDERLAND", NEW YORK BRANCH ----------------- TOTAL $350,000,000 ============ EX-11 8 COMPUTATION OF PER SHARE EARNINGS EXHIBIT 11 AMBAC INC. AND SUBSIDIARIES STATEMENT RE COMPUTATION OF PER SHARE EARNINGS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
1996 1995 1994 ---------- --------- ---------- Net income.............................. $276,317 $167,595 $141,105 -------- -------- -------- Fully diluted shares: Average number of common shares outstanding.......................... 34,965 35,101 35,207 Assumed exercise of dilutive stock options (1).......................... 935 540 416 -------- -------- -------- 35,900 35,641 35,623 -------- -------- -------- Earnings per share assuming full dilution (2)........................... $ 7.70 $ 4.70 $ 3.96 ======== ======== ========
(1) As of December 31, 1996, approximately 2,175,000 stock options and restricted stock units had been granted and were outstanding. Based upon various exercise prices, the total consideration for the options and restricted stock units will be approximately $82.3 million. The dilution would be the equivalent of approximately 935,000 shares, using the Treasury Stock Method, based upon a market value of $66.38 per share. (2) In accordance with Accounting Principles Board Opinion No. 15, any reduction of less than 3% need not be considered as dilution. Accordingly, the Consolidated Statements of Operations on page 31 of the 1996 Annual Report to Stockholders reflect net income per common share of $7.90 for the year ended December 31, 1996. E-1 EX-13.01 9 ANNUAL REPORT TO SHAREHOLDERS EXHIBIT 13.01
STATEMENT OF OPERATIONS HIGHLIGHTS (Dollars in Millions Except Per Share Amounts) Years ended December 31 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------------------------ Gross premiums written $ 247.2 $ 193.3 $ 189.9 $ 318.3 $ 255.1 Net premiums earned 136.6 111.8 117.5 152.0 103.4 Net investment income 144.9 131.0 117.1 104.6 99.7 Losses and loss adjustment expenses 3.8 3.4 2.6 (1.8) 4.3 Underwriting and operating expenses 37.2 34.5 32.8 34.5 27.8 Financial guarantee operating income 225.3 210.8 189.6 255.6 188.0 Financial services operating income (loss) 10.9 5.2 10.6 7.5 (0.3) Equity in income (loss) of affiliate 0.6 (0.2) 1.5 0.5 (1.0) Interest expense 20.9 20.9 18.8 15.8 14.2 Net income 276.3 167.6 141.1 179.3 130.2 Net income per common share 7.90 4.78 4.01 5.08 3.71 BALANCE SHEET HIGHLIGHTS (Dollars in Millions) As of December 31 - ----------------------------------------------------------------------------------------------------------------------------------- Total investments $ 5,200.5 $ 4,441.6 $ 3,764.2 $ 3,132.7 $ 1,769.3 Prepaid reinsurance 168.8 153.4 139.9 161.3 154.3 Total assets 5,876.0 5,309.3 4,287.0 3,807.2 2,228.8 Unearned premiums 991.2 903.0 836.6 782.8 645.3 Losses and loss adjustment expenses 60.2 66.0 65.7 64.0 64.8 Obligations under municipal investment contracts and municipal investment repurchase contracts 2,754.6 2,426.9 2,025.3 1,477.7 382.0 Debentures 223.8 223.7 223.7 223.6 149.2 Total stockholders' equity 1,615.0 1,404.0 1,033.5 1,099.7 861.3 Dividends declared - common stock 21.5 19.5 17.4 15.9 14.4
See accompanying Notes to Consolidated Financial Statements. NET INCOME ($ MILLIONS) [THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL} See Statement of Operations Highlights above RETURN ON EQUITY [THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL} 1992, 16.2%; 1993, 18.3%; 1994, 13.2%; 1995, 13.8%; 1996, 18.3%; 5 yr. avg., 16.0% NET INCOME PER COMMON SHARE [THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL} See Statement of Operations Highlights above CAPITAL RATIO/FINANCIAL RESOURCES RATIO(1) [THE FOLLOWING WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL} 1992, 138:1/79:1; 1993, 133:1/70:1; 1994, 141:1/72:1; 1995, 147:1/73:1; 1996, 155:1/76:1 (1) Capital ratio is net insurance in force divided by qualified statutory capital. Qualified statutory capital is the aggregate of policyholders' surplus and contingency reserves, calculated in accordance with statutory accounting principles. Financial resources ratio is net insurance in force divided by the aggregate of policyholders' reserves, third party capital support and net present value of installment premiums. Policyholders' reserves is the aggregate of unearned premium reserves, loss reserves (including contingency reserves) and policyholders' surplus, calculated in accordance with statutory accounting principles. 3 AMBAC 1996 ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL AMBAC Inc. (the "Company") is a holding company that provides through its affiliates financial guarantee insurance and financial services in both the public and private sectors. The following paragraphs describe the consolidated results of operations of AMBAC Inc. and its subsidiaries (sometimes collectively referred to as the "Company") for 1996, 1995 and 1994, and its financial condition as of December 31, 1996 and 1995. These results are presented for the Company's two business segments: Financial Guarantee Insurance and Financial Services. RESULTS OF OPERATIONS Year Ended December 31, 1996 Versus Year Ended December 31, 1995 Consolidated Net Income The Company's net income in 1996 was $276.3 million or $7.90 per common share, an increase of 65% from $167.6 million or $4.78 per common share in 1995. This increase was due to a number of factors, primarily a net realized gain of $155.6 million (which had a net income per common share effect of $2.88) from the Company's sale of its affiliate, HCIA Inc. ("HCIA") in May 1996. In 1995, the Company recognized a realized gain of $19.1 million (which had a net income per common share effect of $0.34) from the sale of approximately 1.1 million shares of HCIA. Excluding the effects of the respective gains from the sales of HCIA stock in both 1996 and 1995, net income in 1996 increased 13% over 1995 due to higher operating income in both the financial guarantee insurance and financial services business segments. Financial Guarantee Insurance Operating Income. The Company provides financial guarantee insurance through its principal operating subsidiary, AMBAC Indemnity Corporation ("AMBAC Indemnity"), which is a leading insurer of municipal and structured finance obligations. Total financial guarantee insurance operating income in 1996 was $225.3 million, an increase of 7% from $210.8 million in 1995. The increase was primarily the result of higher earned premiums and net investment income, partially offset by net realized losses on sales of investments and higher operating expenses. Gross Par Written. AMBAC Indemnity insured $36.8 billion of par value bonds during 1996, an increase of 42% from $26.0 billion in 1995. Par written in 1996 comprised $26.7 billion from municipal bond insurance and $10.1 billion from structured finance insurance, versus $20.3 billion and $5.7 billion, respectively, in 1995. According to estimates based on industry sources, the total volume of new issues of municipal bonds increased 13% to $180.8 billion in 1996 from $160.6 billion in 1995. During 1996, the insured portion of the new issue municipal bond market increased to 47% from 42% in 1995, reflecting increased demand for insured bonds. During 1996, AMBAC Indemnity's share of the long-term insured new issue municipal bond market, based on gross par amount of insurance written and stated as a percentage of total insured new issue municipal bonds, was approximately 29%, as compared to approximately 25% during 1995. (Market size amounts, insured percentage and market share percentage figures used in this paragraph were determined on a sale date basis, in conformity with industry practices; all other amounts and percentage figures in this discussion were determined on a closing date basis.) Gross Premiums Written. Gross premiums written in 1996 were $247.2 million, an increase of 28% from $193.3 million in 1995. This increase was primarily due to higher new issue municipal finance premiums written. The following table sets forth the amounts of gross premiums written by type and percent of total:
(Dollars in Millions) 1996 1995 - -------------------------------------------------------------------------------- Municipal finance policies: Up-front policies: New issue ........................... $182.9 74% $ 125.2 65% Secondary market .................... 20.4 8 27.3 14 ------------------------------------- Sub-total up-front ................. 203.3 82 152.5 79 ------------------------------------- Installment policies: Annual policies ...................... 9.2 4 7.8 4 Portfolio products ................... 3.8 1 5.4 3 ------------------------------------- Sub-total installment ............... 13.0 5 13.2 7 ------------------------------------- Total municipal finance policies ... 216.3 87 165.7 86 ------------------------------------- Structured finance policies: Up-front ............................. 19.1 8 24.2 12 Installment .......................... 11.8 5 3.4 2 ------------------------------------- Total structured finance policies ... 30.9 13 27.6 14 ------------------------------------- Total gross premiums written ........ $247.2 100% $ 193.3 100% - --------------------------------------------------------------------------------
Adjusted Gross Premiums.While most of AMBAC Indemnity's premiums written are collected up front at policy issuance, a growing portion of premiums are collected on an installment basis. Adjusted gross 21 AMBAC 1996 ANNUAL REPORT premiums, which are defined as up-front premiums written plus the present value of estimated future installment premiums written in the period, were $296.4 million in 1996, up 34% from $221.3 million in 1995. The present value of estimated future installment premiums written in 1996 was $74.0 million, an increase of 66% from $44.6 million in 1995. The aggregate net present value of estimated future installment premiums was $157.7 million and $110.0 million as of December 31, 1996 and 1995, respectively. Ceded Premiums Written. Ceded premiums written in 1996 were $37.8 million, versus $28.6 million in 1995. Ceded premiums written in 1995 were reduced by $18.1 million in return premiums from the cancellation of reinsurance contracts. A portion of the return premiums, $15.7 million, was deferred in unearned premiums, with the remainder included in accelerated premiums earned in 1995. Excluding the return premiums in 1995, ceded premiums written in 1996 decreased by 19% compared to 1995. The decrease reflects lower premiums ceded under facultative reinsurance agreements in 1996. Ceded premiums written, exclusive of return premiums, were 15.3% and 24.2% of gross premiums written in 1996 and 1995, respectively. Net Premiums Written. Net premiums written in 1996 were $209.4 million, an increase of 27% from $164.7 million in 1995. The increase reflects higher gross premiums written in 1996, partially offset by higher premiums ceded to reinsurers (after the effect of the 1995 return premium). Net Premiums Earned. Net premiums earned during 1996 were $136.6 million, an increase of 22% from $111.8 million in 1995. This increase was primarily the result of the growth in premiums earned from the underlying book of business during the year as well as higher premiums earned from refundings, calls and other accelerations in 1996. Net premiums earned in 1996 included $31.3 million (net income per common share effect of $0.51) from refundings, calls and other accelerations of previously insured issues. Net premiums earned in 1995 included $22.6 million (net income per common share effect of $0.36) from refundings, calls and other accelerations. Refunding levels vary depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. Excluding the effect of accelerated earnings, net premiums earned in 1996 were $105.3 million, an increase of 18% from $89.2 million in 1995. Net Investment Income. Net investment income in 1996 was $144.9 million, an increase of 11% from $131.0 million in 1995. This increase was primarily attributable to the growth of the investment portfolio. AMBAC Indemnity's investments in tax-exempt securities amounted to 79% of the total market value of the portfolio as of December 31, 1996, versus 69% as of December 31, 1995. The average pre-tax yield-to-maturity on the financial guarantee insurance investment portfolio was 6.47% as of December 31, 1996, unchanged from December 31, 1995. Net Realized (Losses) Gains. Financial guarantee related net realized (losses) gains in 1996 were ($20.5) million, versus $0.2 million in 1995. The net realized losses were generated for tax planning purposes to partially offset the realized gain from the sale of HCIA. Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses in 1996 were $3.8 million, versus $3.4 million in 1995. Losses and loss adjustment expenses are generally based upon estimates of the ultimate aggregate losses inherent in the obligations insured. Losses and loss adjustment expenses, exclusive of salvage recognized, were $5.1 million and $4.1 million in 1996 and 1995, respectively. Salvage recognized was $1.3 million in 1996, compared to $0.7 million in 1995. Underwriting and Operating Expenses. Underwriting and operating expenses were $37.2 million in 1996, an increase of 8% from $34.5 million in 1995. Underwriting and operating expenses consist of gross underwriting and operating expenses, less the deferral to future periods of expenses and reinsurance commissions related to the acquisition of new insurance contracts, plus the amortization of previously deferred expenses and reinsurance commissions. During 1996, AMBAC Indemnity's gross underwriting and operating expenses were $56.4 million, an increase of 11% from $50.9 million in 1995, primarily due to increased compensation costs and premium taxes. Underwriting and operating expenses deferred were $32.3 million and $27.8 million in 1996 and 1995, respectively. Reinsurance commissions which related to the current period were ($0.6) million and ($1.2) million in 1996 and 1995, respectively. The amortization of previously deferred expenses and reinsurance commissions was $12.5 million and $10.2 million in 1996 and 1995, respectively. 22 AMBAC 1996 ANNUAL REPORT Financial Services Through its financial services subsidiaries, the Company provides investment contracts, interest rate swaps and investment management and advisory services principally to states, municipalities, municipal authorities and hospitals and health organizations. Financial services operating income in 1996 was $10.9 million, versus $5.2 million in 1995. The increase was primarily due to recoveries in 1996 of net unrealized mark-to-market losses in the portfolio of municipal interest rate swaps which were recognized in 1995. The Company manages the municipal interest rate swap portfolio to be market neutral to overall interest rates. However, the Company does retain certain "basis risk," defined as the relationship between changes in floating rate tax-exempt and floating rate taxable interest rates. Since the third quarter of 1995, all municipal interest rate swaps transacted contain provisions designed to protect the Company against certain forms of tax reform, thus mitigating basis risk. Also contributing to the increased operating income was higher net interest income from municipal investment contracts due to higher volume, partially offset by higher operating expenses related to starting up an investment advisory business. Total financial services revenues in 1996 were $22.1 million, versus $13.0 million in 1995. Financial services expenses in 1996 were $11.2 million, versus $7.8 million in 1995. Corporate Items Equity in Income (Loss) of Affiliate. In May 1996, the Company sold its remaining interest in HCIA common stock. The Company's share of HCIA's income in 1994, 1995 and for the first four months of 1996 is reported as "Equity in income (loss) of affiliate." Equity in income (loss) of affiliate was $0.6 million in 1996, as compared to ($0.2) million in 1995. Interest Expense. Interest expense in 1996 was $20.9 million, unchanged from 1995. Other Income (Deductions), Net. Other income (deductions), net, includes investment income and operating expenses of the holding company, AMBAC Inc. Also included in this line is the Company's 61% equity interest in the operating earnings of AMBAC Connect Inc., a developer of procurement software, which the Company acquired in August 1996. Other income (deductions), net, increased to $3.2 million in 1996 from $0.2 million in 1995, primarily due to additional investment income generated by the holding company from the proceeds of the sale of HCIA. Other Net Realized Gains (Losses). The net realized gain in 1996 resulted primarily from the sale of its remaining holdings in HCIA in a secondary public offering yielding net proceeds to the Company of $202.6 million. The sale resulted in a net realized gain of $155.6 million pre-tax, $100.6 million after- tax (net income per common share effect of $2.88). During 1995, the Company sold approximately 1.1 million shares of its HCIA stock in a public offering resulting in a realized gain of $19.1 million (which had a net income per common share effect of $0.34). Income Taxes. Income taxes for 1996 were at an effective rate of 26.4%, compared to 21.7% in 1995. The increase in the effective rate is primarily due to the realized gain on the sale of HCIA in 1996 taxed at the statutory rate of 35%. Supplemental Analytical Financial Data Core Earnings.(1) In 1996, core earnings were $170.5 million, an increase of 17% from $145.5 million in 1995. The increase in core earnings was primarily the result of continued growth in premiums earned from the underlying book of business and net investment income from financial guarantee insurance operations, as well as increased operating income from the financial services division. Core earnings, which the Company reports as analytical data, exclude the effect on consolidated net income from net realized gains and losses, net insurance premiums earned from refundings, calls and other accelerations and certain non-recurring items. Operating Earnings.(1) Operating earnings in 1996 were $188.3 million, an increase of 19% from $158.2 million in 1995. The Company defines operating earnings as net income, less the effect of net realized gains and losses and certain non-recurring items. Following is a table reconciling net income computed in accordance with Generally Accepted Accounting Principles ("GAAP") to operating earnings and core earnings for the years ended December 31, 1996 and 1995:
(Dollars in Millions) 1996 1995 - ------------------------------------------------------------------------------- Net income ......................................... $276.3 $167.6 Net realized gains, after tax ...................... (88.0) (11.9) Non-recurring item, after tax(a) ................... -- 2.5 ----------------------- Operating earnings ................................. 188.3 158.2 Premiums earned from refundings, calls and other accelerations, after tax .......... (17.8) (12.7) ----------------------- Core earnings ...................................... $170.5 $145.5 -----------------------
(a) Non-recurring item in 1995 was an HCIA charge related to an acquisition. 23 AMBAC 1996 ANNUAL REPORT RESULTS OF OPERATIONS Year Ended December 31, 1995 Versus Year Ended December 31, 1994 Consolidated Net Income The Company's net income in 1995 was $167.6 million or $4.78 per common share, an increase of 19% from $141.1 million or $4.01 per common share in 1994. The increase was due to a number of factors, primarily a realized gain of $19.1 million (which had a net income per common share effect of $0.34) from the August 1995 sale of approximately 1.1 million shares of HCIA in a secondary public offering. Additionally, the increase in net income in 1995 versus 1994 was due to higher financial guarantee insurance operating income, partially offset by lower financial services operating income. Financial Guarantee Insurance Operating Income. Total financial guarantee insurance operating income in 1995 was $210.8 million, an increase of 11% from $189.6 million in 1994. The increase was primarily due to the growth of investment income, higher premiums earned from the underlying book of business and realized gains on sales of investments, partially offset by lower accelerated premiums earned from refundings, calls and other accelerations. Gross Par Written. AMBAC Indemnity insured $26.0 billion in par value bonds during 1995, an increase of 18% from $22.1 billion in 1994. Par written in 1995 comprised $20.3 billion from municipal bond insurance and $5.7 billion from structured finance insurance, versus $20.3 billion and $1.8 billion, respectively, in 1994. According to estimates based on industry sources, the total volume of new issues of municipal bonds decreased 3% to $160.6 billion during 1995 from $164.9 billion in 1994. During 1995, the insured portion of the new issue municipal bond market increased to 42% from 38% in 1994, reflecting increased demand for insured bonds. During 1995, AMBAC Indemnity's share of the long-term insured new issue municipal bond market, based on gross par amount of insurance written and stated as a percentage of total insured new issue municipal bonds, was approximately 25%, as compared to approximately 28% during 1994. (Market size amounts, insured percentage and market share percentage figures used in this paragraph were determined on a sale date basis, in conformity with industry practices; all other amounts and percentage figures in this discussion were determined on a closing date basis.) Gross Premiums Written.Gross premiums written in 1995 were $193.3 million, an increase of 2% from $189.9 million in 1994. This increase was primarily due to higher structured finance premiums written, partially offset by lower new issue municipal premium rates. The following table sets forth the amounts of gross premiums written by type and percent of total:
(Dollars in Millions) 1995 1994 - -------------------------------------------------------------------------------- Municipal finance policies: Up-front policies: New issue ........................... $125.2 65% $ 136.7 72% Secondary market .................... 27.3 14 23.7 12 ----------------------------------- Sub-total up-front ................. 152.5 79 160.4 84 ----------------------------------- Installment policies: Annual policies ...................... 7.8 4 4.9 3 Portfolio products ................... 5.4 3 7.9 4 ----------------------------------- Sub-total installment ............... 13.2 7 12.8 7 ----------------------------------- Total municipal finance policies ... 165.7 86 173.2 91 ----------------------------------- Structured finance policies: Up-front ............................. 24.2 12 15.2 8 Installment .......................... 3.4 2 1.5 1 ----------------------------------- Total structured finance policies ... 27.6 14 16.7 9 ----------------------------------- Total gross premiums written ........ $193.3 100% $ 189.9 100% - --------------------------------------------------------------------------------
Adjusted Gross Premiums. Adjusted gross premiums, which are defined as up-front premiums written plus the present value of estimated future installment premiums written in the period, were $221.3 million in 1995, up 12% from $197.1 million in 1994. The present value of estimated future installment premiums written in the year 1995 was $44.6 million, more than double the $21.5 million in 1994. The aggregate net present value of estimated future installment premiums written was $110.0 million and $71.0 million as of December 31, 1995 and 1994, respectively. Ceded Premiums Written. Ceded premiums written in 1995 were $28.6 million, versus ($2.8) million in 1994. Ceded premiums written in 1995 and 1994 include $18.1 million and $30.5 million, respectively, in return premiums from the cancellation of reinsurance contracts. A portion of these return premiums, $15.7 million and $25.9 million, was deferred in unearned premiums in 1995 and 1994, respectively, with the remainder included in accelerated premiums earned in 1995 and 1994. Excluding these return premiums, ceded premiums written in 1995 increased by 69% compared to 1994. The increase was due to higher premiums ceded under facultative reinsurance agreements primarily related to structured finance transactions, as well as increased premiums ceded under surplus share reinsurance agreements in 1995, partially offset by a decrease in premiums ceded under quota share reinsurance agreements 24 AMBAC 1996 ANNUAL REPORT during 1995. Ceded premiums written, exclusive of return premiums, were 24.2% and 14.6% of gross premiums written in 1995 and 1994, respectively. Net Premiums Written. Net premiums written in 1995 were $164.7 million, a decrease of 15% from $192.7 million in 1994. The decrease reflects higher premiums ceded to reinsurers in 1995 and higher return premiums from cancellation of reinsurance contracts in 1994. Net Premiums Earned. Net premiums earned during 1995 were $111.8 million, a decrease of 5% from $117.5 million in 1994. This decrease was primarily due to the lower volume of refundings, calls and other accelerations of AMBAC-insured municipal bonds in 1995, partially offset by the growth in premiums earned from the underlying book of business during the year. Net premiums earned in 1995 included $22.6 million (net income per common share effect of $0.36) from refundings, calls and other accelerations of previously insured issues. Net premiums earned in 1994 included $35.9 million (net income per common share effect of $0.58) from refundings, calls and other accelerations. Excluding the effect of accelerated earnings from refundings, calls and other accelerations, net premiums earned in 1995 were $89.2 million, an increase of 9% from $81.6 million in 1994. Net Investment Income. Net investment income in 1995 was $131.0 million, an increase of 12% from $117.1 million in 1994. The increase was primarily attributable to the growth of the investment portfolio. AMBAC Indemnity's investments in tax-exempt securities amounted to 69% of the total market value of the portfolio as of December 31, 1995, versus 78% at December 31, 1994. The average pre-tax yield-to-maturity on the financial guarantee investment portfolio was 6.47% and 6.61% as of December 31, 1995 and 1994, respectively. Net Realized (Losses) Gains. Financial guarantee related net realized (losses) gains in 1995 were $0.2 million, versus ($13.4) million in 1994. The net realized losses in 1994 were generated primarily to recover taxes paid on prior years' realized gains, for which the carry-back limitation was otherwise due to expire. Other Income. Other income in 1995 was $5.6 million, versus $3.8 million in 1994. The increase was primarily due to higher income related to certain real estate interests. Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses in 1995 were $3.4 million, versus $2.6 million in 1994. The increase in losses and loss adjustment expenses was primarily due to lower salvage recognized in 1995. Losses and loss adjustment expenses, exclusive of salvage recognized, were $4.1 million and $7.4 million in 1995 and 1994, respectively. Salvage recognized was $0.7 million in 1995, compared to $4.8 million in 1994. Underwriting and Operating Expenses. Underwriting and operating expenses were $34.5 million in 1995, an increase of 5% from $32.8 million in 1994. During 1995, AMBAC Indemnity's gross underwriting and operating expenses were $50.9 million, a decrease of 3% from $52.6 million in 1994. Underwriting and operating expenses deferred were $27.8 million and $28.5 million in 1995 and 1994, respectively. Reinsurance commissions which related to the current period were ($1.2) million and $0.6 million in 1995 and 1994, respectively. The amortization of previously deferred expenses and reinsurance commissions was $10.2 million and $9.3 million in 1995 and 1994, respectively. Financial Services Financial services operating income in 1995 was $5.2 million, versus $10.6 million in 1994. The decrease was primarily due to the recognition of net unrealized mark-to-market losses in the portfolio of municipal interest rate swaps due to the threat of tax reform in 1995 which caused projected floating rate tax-exempt interest rates to increase in relation to floating rate taxable interest rates. As discussed above under "Results of Operations - Year Ended December 31, 1996 Versus Year Ended December 31, 1995, Financial Services," the Company manages its municipal interest rate swaps portfolio to be market neutral to overall interest rates, but does retain certain basis risk. Also, contributing to the financial services operating income decline in 1995 as compared to 1994 was lower net interest income from municipal investment contracts and higher financial services operating expenses. Total financial services revenues in 1995 were $13.0 million, versus $16.7 million in 1994. Financial services expenses in 1995 were $7.8 million, versus $6.1 million in 1994. Corporate Items Equity in Income (Loss) of Affiliate. During 1995, the Company reduced its equity holdings in HCIA to less than 50% and started reporting its share of HCIA's 25 AMBAC 1996 ANNUAL REPORT income as "Equity in income (loss) of affiliate." Equity in income (loss) of affiliate was ($0.2) million in 1995, versus $1.5 million in 1994. The loss in 1995 was primarily due to HCIA's recording of a non-recurring charge related to a 1995 acquisition. Excluding this charge, equity in income of affiliate would have been $3.5 million. Interest Expense. Interest expense in 1995 was $20.9 million, an increase of 11% from $18.8 million in 1994, primarily due to lower net payments received under an interest rate swap related to the Company's debentures. Income Taxes. Income taxes in 1995 were at an effective rate of 21.7%, relatively unchanged from the prior year's effective rate of 21.6%. Supplemental Analytical Financial Data Core Earnings.(1) In 1995, the Company's core earnings were $145.5 million, an increase of 11% from $131.2 million in 1994. The increase in core earnings was primarily the result of the continued growth in net premiums earned from the underlying book of business and net investment income from financial guarantee insurance operations, partially offset by lower financial services operating income. Operating Earnings.(1) Operating earnings in 1995 were $158.2 million, an increase of 4% from $151.5 million in 1994. Following is a table reconciling net income computed in accordance with GAAP to operating earnings and core earnings for the years ended December 31, 1995 and 1994:
(Dollars in Millions) 1995 1994 - -------------------------------------------------------------------------------- Net income ......................................... $167.6 $141.1 Net realized (gains)/losses, after tax ............. (11.9) 10.4 Non-recurring item, after tax (a) ................. 2.5 -- ------------------------ Operating earnings ................................. 158.2 151.5 Premiums earned from refundings, calls and other accelerations, after tax .......... (12.7) (20.3) ------------------------ Core earnings ...................................... $145.5 $131.2 - --------------------------------------------------------------------------------
(a) Non-recurring item in 1995 was an HCIA charge related to an acquisition. ACQUISITIONS Cadre Financial Services, Inc. ("Cadre"). On December 31, 1996, the Company acquired substantially all of the assets of Cadre for approximately $20.0 million in Company stock and cash. Cadre, based in Ronkonkoma, New York, is a provider of cash management and investment advisory services to local school districts, hospitals and health care organizations and municipalities. At December 31, 1996, Cadre was providing investment administration services for approximately 2,600 clients with approximately $5.9 billion in assets. Included in the assets under administration at December 31, 1996, were approximately $1.9 billion of assets for which Cadre provides direct investment advisory services. AMBAC Connect Inc. ("ACI"). In August 1996, the Company acquired a controlling equity interest in ACI, the successor to Advanced Procurement Systems, Inc. ACI, based in Austin, Texas, develops and markets software for governmental procurement applications. LIQUIDITY AND CAPITAL RESOURCES AMBAC Inc. Liquidity. The Company's liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), is largely dependent upon AMBAC Indemnity's ability to pay dividends or make payments to the Company and external financings. Pursuant to Wisconsin insurance laws, AMBAC Indemnity may declare dividends, provided that, after giving effect to the distribution, it would not violate certain statutory equity, solvency and asset tests. However, on April 30, 1996, AMBAC Indemnity, in conjunction with the sale of the Company's remaining holdings in HCIA common stock, delivered to the Company (in the form of an extraordinary dividend) its 2,378,672 shares of HCIA common stock, at fair value. The Wisconsin Commissioner approved such dividend. As a result, any dividends paid by AMBAC Indemnity to the Company through June 30, 1997, require pre-approval from the Wisconsin Commissioner. The Wisconsin Commissioner has stated to AMBAC Indemnity management that it does not foresee any reason pre-approval of anticipated common stock dividends paid through June 30, 1997 would not be given. Anticipated common stock dividends paid thereafter and through year-end 1997, will not require such pre-approval. During 1996, AMBAC Indemnity paid dividends of $40.0 million on its common stock to the Company. For further discussion, see Note 8 of Notes to Consolidated Financial Statements. The Company's principal uses of liquidity are for the payment of its operating expenses, interest 26 AMBAC 1996 ANNUAL REPORT on its debt, dividends on its shares of common stock and capital investments in its subsidiaries. Based on the amount of dividends that AMBAC Indemnity expects to pay during 1997 with the anticipated prior approval of regulatory authorities along with the proceeds from its sale of HCIA common stock, the Company believes it will have sufficient liquidity to satisfy its liquidity needs over the next twelve months, including the payment of dividends on the Common Stock in accordance with its dividend policy. Beyond the next twelve months, AMBAC Indemnity's ability to declare and pay dividends to the Company may be influenced by a variety of factors, including adverse market changes, insurance regulatory changes and changes in general economic conditions. Consequently, although the Company believes that it will continue to have sufficient liquidity to meet its debt service and other obligations over the long term, no assurance can be given that AMBAC Indemnity will be permitted to dividend amounts sufficient to pay all of the Company's operating expenses, debt service obligations and dividends on its Common Stock. AMBAC Indemnity Liquidity. The principal uses of AMBAC Indemnity's liquidity are the payment of operating expenses, reinsurance premiums, income taxes and dividends to the Company. The Company believes that AMBAC Indemnity's operating liquidity needs can be funded exclusively from its operating cash flow. The principal sources of AMBAC Indemnity's liquidity are gross premiums written, scheduled investment maturities and net investment income. The majority of premiums for AMBAC Indemnity's financial guarantee insurance policies are payable in full at the outset of the term of the policy, even though premiums are earned over the life of such policies for financial accounting purposes. Financial Services Liquidity. The principal uses of liquidity by the Company's financial services subsidiaries are the payment of investment contract obligations pursuant to defined terms, net obligations under interest rate swaps, operating expenses and income taxes. The Company believes that its financial services operating liquidity needs can be funded primarily from its operating cash flow and the maturity of its invested assets. The principal sources of financial services liquidity are proceeds from issuance of investment contracts, net investment income, maturities of securities from its investment portfolio which are invested with the objective of matching the duration of its obligations under the investment contracts, and net receipts from interest rate swaps and related hedges. The Company's investment objectives with respect to investment contracts are to achieve the highest after-tax total return, subject to a minimum average quality rating of Aa/AA on invested assets, and to maintain cash flow matching of invested assets to funded liabilities to minimize interest rate and liquidity exposure. The Company maintains a portion of its financial services assets in short-term investments and repurchase agreements in order to meet unexpected liquidity needs. Credit Facilities. As of December 31, 1996, the Company and AMBAC Indemnity had a revolving credit facility with two major international banks, as co-agents, for $100.0 million, which expires in July 1998. This facility is available for general corporate purposes, including the payment of claims. As of December 31, 1996 and 1995, no amounts were outstanding under this credit facility. AMBAC Indemnity has an agreement with a group of Aaa/AAA-rated international banks for a $350.0 million credit facility, expiring in 2003. The terms of this facility were renegotiated in December 1996, to increase the facility from $300.0 million to $350.0 million; and to extend the expiration date from December 2, 2002 to December 2, 2003. This facility is a seven-year stand-by irrevocable limited recourse line of credit which will provide liquidity to AMBAC Indemnity in the event claims from municipal obligations exceed specified levels. Repayment of any amounts drawn under the line will be limited primarily to the amount of any recoveries of losses related to policy obligations. As of December 31, 1996 and 1995, no amounts were outstanding under this line. Treasury Stock Repurchase Program. During 1996, the Company acquired approximately 597,000 treasury shares for an aggregate amount of $31.8 million. Since inception of the Stock Repurchase Program, the Company has acquired approximately 1,061,000 shares for an aggregate amount of $49.6 million. 27 AMBAC 1996 ANNUAL REPORT Adjusted Book Value. (2) Adjusted Book Value ("ABV") per common share increased 11% to $62.50 at December 31, 1996 from $56.47 at December 31, 1995. The following table reconciles Book Value Per Share to Adjusted Book Value Per Share as of December 31, 1996 and 1995:
1996(a) 1995(a) - -------------------------------------------------------------------------------- Book value per share ............................... $46.02 $40.04 After-tax value of: Net unearned premium reserve ...................... 15.25 13.89 Deferred acquisition costs ........................ (1.74) (1.54) Present value of installment premiums ............. 2.91 2.05 Unrealized gain on investment in HCIA(b) .......... -- 2.77 Unrealized gain (loss) on investment contract liabilities .............................. 0.06 (0.74) ---------------------- Adjusted book value per share ...................... $62.50 $56.47 - --------------------------------------------------------------------------------
(a) Numbers may not add due to rounding. (b) The Company sold its remaining investment in HCIA on May 6, 1996. Balance Sheet. As of December 31, 1996, the fair value of the Company's consolidated investment portfolio was $5.20 billion, an increase of 17% from $4.44 billion at December 31, 1995. The increase was primarily due to the growth of the Company's financial guarantee insurance and financial services operations during 1996, partially offset by a decline in the market value of investments resulting from the increase in interest rates during 1996. Cash Flows. Net cash provided by operating activities was $190.6 million, $231.3 million and $265.6 million during 1996, 1995 and 1994, respectively. These cash flows were primarily provided by the financial guarantee insurance operations. Net cash provided by financing activities was $463.2 million, $177.7 million and $534.2 million during 1996, 1995 and 1994, respectively. This activity included $499.2 million, $196.8 million and $562.7 million in municipal investment contracts issued (net of draws paid) in 1996, 1995 and 1994, respectively. The total cash provided by operating and financing activities was $653.8 million, $409.0 million and $799.8 million during 1996, 1995 and 1994, respectively. From these totals, $658.2 million, $401.3 million and $799.5 million was used in investing activities, principally purchases of investment securities during 1996, 1995 and 1994, respectively. Off-Balance-Sheet Risk. In the normal course of business, the Company uses interest rate contracts for hedging purposes as part of its overall interest rate risk management. In addition, the Company's financial services subsidiaries include a dealer of interest rate swaps primarily to states, municipalities and municipal authorities. This subsidiary manages its interest rate swap business with the goal of being market neutral to changes in taxable interest rates. In the ordinary course of business, it manages a variety of risks - principally credit, market, liquidity, operational, and legal. These risks are identified, measured, and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. For additional information, see Notes 12 and 13 in Notes to Consolidated Financial Statements. Material Commitments. The Company has made no commitments for material capital expenditures within the next twelve months. However, management continually evaluates opportunities to expand the Company's businesses through internal development of new products as well as acquisitions. FOOTNOTES (1) Core earnings and operating earnings are not substitutes for net income computed in accordance with GAAP, but are important measures used by management, equity analysts and investors to measure the financial results of the Company. (2) Adjusted book value ("ABV"), which is not promulgated under GAAP, is used by management, equity analysts and investors as a measurement of the Company's intrinsic value with no benefit given for ongoing business activity. Management derives adjusted book value by beginning with stockholders' equity (book value) and adding or subtracting the after-tax value of: the net unearned premium reserve, deferred acquisition costs, the present value of estimated net future installment premiums, the unrealized gain on the investment in HCIA (prior to sale on May 6, 1996), and the unrealized gain or loss on investment contract liabilities. The definition of ABV used by the Company may differ from definitions of ABV used by other public holding companies of financial guarantee insurers. The adjustments described above will not be realized until future periods and may differ materially from the amounts used in determining ABV. 28 AMBAC 1996 ANNUAL REPORT REPORT ON MANAGEMENT'S RESPONSIBILITIES The management of AMBAC is responsible for the integrity and objectivity of the financial statements and all other financial information presented in this Annual Report and for assuring that such information fairly presents the consolidated financial position and operating results of AMBAC. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles using management's best estimates and judgment. The financial information presented elsewhere in this Annual Report is consistent with that in the consolidated financial statements. AMBAC maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded against loss or unauthorized use and that the financial records are reliable for use in preparing financial statements and maintaining accountability of assets. Qualified and professional financial personnel maintain and monitor these internal controls on a continuous basis. The concept of reasonable assurance is based on the recognition that the cost of a system of internal control should not exceed the related benefits. AMBAC's consolidated financial statements have been audited by KPMG Peat Marwick LLP, independent auditors, whose audits were made in accordance with generally accepted auditing standards and included a review of internal accounting controls to the extent necessary to express an opinion on the fairness of the consolidated financial statements. The Audit Committee of the Board of Directors, comprised solely of outside directors, meets regularly with financial management, the independent auditors and the internal auditors to review the work and procedures of each. The independent auditors and the internal auditors have free access to the Audit Committee, without the presence of management, to discuss the results of their work and their considerations of AMBAC and its subsidiaries and the quality of AMBAC's financial reporting. The Board of Directors, upon recommendation of the Audit Committee, appoints the independent auditors, subject to stockholder approval. /s/ Phillip B. Lassiter Phillip B. Lassiter Chairman, President and Chief Executive Officer /s/ Frank J. Bivona Frank J. Bivona Senior Vice President, Chief Financial Officer and Treasurer January 30, 1997 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders AMBAC Inc. We have audited the accompanying consolidated balance sheets of AMBAC Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of AMBAC Inc.'s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AMBAC Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP New York, New York January 30, 1997 29 AMBAC 1996 ANNUAL REPORT CONSOLIDATED BALANCE SHEETS
AMBAC INC. AND SUBSIDIARIES (Dollars in Thousands Except Per Share Amounts) December 31, 1996 1995 - -------------------------------------------------------------------------------------------------------- ASSETS: Investments: Bonds, at fair value (amortized cost of $4,979,017 in 1996 and $4,082,791 in 1995) ........ $ 5,088,031 $ 4,264,904 Short-term investments, at cost (approximates fair value) .............. 112,511 176,689 -------------------------- Total investments ................................................... 5,200,542 4,441,593 Cash ...................................................................... 7,734 12,167 Securities purchased under agreements to resell ........................... 201,169 240,280 Receivable for municipal investment contracts ............................. 33,299 204,797 Receivable for securities sold ............................................ 18,467 14,523 Investment income due and accrued ......................................... 65,920 56,370 Investment in affiliate ................................................... -- 45,019 Prepaid reinsurance ....................................................... 168,786 153,372 Deferred acquisition costs ................................................ 94,212 82,620 Other assets .............................................................. 85,836 58,538 -------------------------- Total assets ........................................................ $ 5,875,965 $ 5,309,279 -------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY: Liabilities: Unearned premiums ...................................................... $ 991,224 $ 903,026 Losses and loss adjustment expenses .................................... 60,220 65,996 Ceded reinsurance balances payable ..................................... 7,438 14,654 Obligations under municipal investment contracts ....................... 2,417,817 2,185,746 Obligations under municipal investment repurchase contracts ............ 336,773 241,112 Deferred income taxes .................................................. 80,086 103,697 Current income taxes ................................................... 6,538 5,125 Debentures ............................................................. 223,798 223,732 Accrued interest payable ............................................... 29,958 25,494 Accounts payable and other liabilities ................................. 57,689 44,578 Payable for securities purchased ....................................... 49,408 92,131 -------------------------- Total liabilities ................................................... 4,260,949 3,905,291 Stockholders' equity: Preferred stock, par value $0.01 per share; authorized shares - 4,000,000; issued and outstanding shares - none ...................... -- -- Common stock, Class A, par value $0.01 per share; authorized shares - 20,000,000; issued and outstanding shares - none ............ -- -- Common stock, par value $0.01 per share; authorized shares - 50,000,000; issued shares - 35,340,192 at December 31, 1996 and December 31, 1995 ................................................ 353 353 Additional paid-in capital ............................................. 498,401 492,495 Unrealized gains on investments, net of tax ............................ 58,911 102,470 Retained earnings ...................................................... 1,072,418 819,479 Common stock held in treasury at cost, 249,807 shares at December 31, 1996 and 276,619 at December 31, 1995 ................... (15,067) (10,809) -------------------------- Total stockholders' equity .......................................... 1,615,016 1,403,988 ------------------------ Total liabilities and stockholders' equity .......................... $5,875,965 $ 5,309,279 - ---------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 30 AMBAC 1996 ANNUAL REPORT CONSOLIDATED STATEMENTS OF OPERATIONS
AMBAC INC. AND SUBSIDIARIES (Dollars in Thousands Except Per Share Amounts) Years Ended December 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------- Financial guarantee insurance operations: Gross premiums written .................... $ 247,208 $ 193,326 $ 189,906 Ceded premiums written .................... (37,793) (28,606) 2,815 -------------------------------------------- Net premiums written ................... 209,415 164,720 192,721 Increase in unearned premiums ............. (72,786) (52,900) (75,257) -------------------------------------------- Net premiums earned ..................... 136,629 111,820 117,464 Net investment income ..................... 144,941 131,049 117,112 Net realized (losses) gains ............... (20,531) 177 (13,386) Other income .............................. 5,261 5,580 3,836 -------------------------------------------- 266,300 248,626 225,026 -------------------------------------------- Losses and loss adjustment expenses ....... 3,778 3,377 2,593 Underwriting and operating expenses ....... 37,182 34,450 32,849 -------------------------------------------- 40,960 37,827 35,442 -------------------------------------------- Financial guarantee insurance operating income .................................... 225,340 210,799 189,584 Financial services operating income .......... 10,943 5,216 10,571 Equity in income (loss) of affiliate ......... 627 (185) 1,492 Interest expense ............................. (20,925) (20,934) (18,786) Other income (deductions), net ............... 3,208 175 (310) Other net realized gains (losses) ............ 156,313 19,103 (2,632) -------------------------------------------- Income before income taxes ................ 375,506 214,174 179,919 Provision for income taxes ................... 99,189 46,579 38,814 -------------------------------------------- Net income ................................ $ 276,317 $ 167,595 $ 141,105 -------------------------------------------- Net income per common share ............... $ 7.90 $ 4.78 $ 4.01 -------------------------------------------- Weighted average number of common shares outstanding .................. 34,964,814 35,100,881 35,207,364 - ---------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 31 AMBAC 1996 ANNUAL REPORT CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AMBAC INC. AND SUBSIDIARIES (Dollars in Thousands) Years Ended December 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------- PREFERRED STOCK: Balance at January 1 and December 31 ............. $ -- $ -- $ -- ------------------------------------- COMMON STOCK, CLASS A: Balance at January 1 and December 31 ............. $ -- $ -- $ -- ------------------------------------- COMMON STOCK: Balance at January 1 and December 31 ............. $ 353 $ 353 $ 353 ------------------------------------- ADDITIONAL PAID-IN CAPITAL: Balance at January 1 ............................. $ 492,495 $ 477,467 $ 476,419 Issuance of stock ................................ 3,624 (5) 585 Sale of affiliate, net of tax .................... -- 14,356 -- Other ............................................ 2,282 677 463 ------------------------------------- Balance at December 31 ........................... $ 498,401 $ 492,495 $ 477,467 ------------------------------------- UNREALIZED GAINS (LOSSES) ON INVESTMENTS, NET OF TAX: Balance at January 1 ............................. 102,470 ($106,264) $ 73,174 Change in unrealized gains (losses) .............. (43,559) 208,734 (179,438) ------------------------------------- Balance at December 31 ........................... $ 58,911 $ 102,470 ($106,264) ------------------------------------- RETAINED EARNINGS: Balance at January 1 ............................. $ 819,479 $ 673,129 $ 549,781 Net income ....................................... 276,317 167,595 141,105 Dividends declared-common stock .................. (21,500) (19,484) (17,429) Other ............................................ (1,878) (1,761) (328) ------------------------------------- Balance at December 31 ........................... $ 1,072,418 $ 819,479 $ 673,129 ------------------------------------- COMMON STOCK HELD IN TREASURY AT COST: Balance at January 1 ............................. ($ 10,809) ($ 11,198) $ -- Cost of shares acquired during year .............. (31,751) (5,913) (11,907) Issued under stock incentive plan ................ 17,211 6,302 709 Issued to acquire subsidiary ..................... 10,282 -- -- ------------------------------------- Balance at December 31 ........................... ($ 15,067) ($ 10,809) ($ 11,198) - ----------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 32 AMBAC 1996 ANNUAL REPORT CONSOLIDATED STATEMENTS OF CASH FLOWS
AMBAC INC. AND SUBSIDIARIES (Dollars in Thousands) Years Ended December 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................... $ 276,317 $ 167,595 $ 141,105 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ......................... 1,986 4,765 6,079 Amortization of bond premium and discount ............. (1,603) 324 3,384 Current income taxes .................................. 1,413 15,713 (7,855) Deferred income taxes ................................. 4,497 13,727 15,584 Deferred acquisition costs ............................ (11,592) (10,846) (20,757) Unearned premiums, net ................................ 72,786 52,900 75,257 Losses and loss adjustment expenses ................... (5,776) 334 1,625 Ceded reinsurance balances payable .................... (7,216) 13,746 (2,963) Investment income due and accrued ..................... (9,550) (6,465) (9,911) Accrued interest payable .............................. 4,464 1,668 6,084 (Gain) loss on sales of investments and affiliates .... (136,175) (19,222) 15,695 Accounts payable and other liabilities ................ 13,111 (6,240) 20,110 Other, net ............................................ (12,032) 3,340 22,120 ------------------------------------------ Net cash provided by operating activities .......... 190,630 231,339 265,557 ------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of bonds ............................. 1,911,909 2,955,475 2,024,880 Proceeds from matured bonds .............................. 959,527 660,181 352,791 Purchases of bonds ....................................... (3,825,803) (3,820,086) (3,332,696) Change in short-term investments ......................... 64,178 (38,714) (28,933) Securities purchased under agreements to resell .......... 39,111 (152,269) 193,716 Proceeds from sale of affiliate .......................... 202,609 28,502 -- Other, net ............................................... (9,783) (34,380) (9,304) ------------------------------------------ Net cash used in investing activities ................. (658,252) (401,291) (799,546) ------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid ........................................... (21,500) (19,484) (17,429) Proceeds from issuance of municipal investment contracts ..................................... 1,696,813 1,374,856 1,685,809 Payments for municipal investment contract draws ......... (1,197,584) (1,178,083) (1,123,096) Purchases of treasury stock .............................. (31,751) (5,913) (11,907) Proceeds from sale of treasury stock ..................... 17,211 6,302 709 Other, net ............................................... -- -- 164 ------------------------------------------ Net cash provided by financing activities ............. 463,189 177,678 534,250 ------------------------------------------ Net Cash Flow ............................................ (4,433) 7,726 261 Cash at January 1 ..................................... 12,167 4,441 4,180 ------------------------------------------ Cash at December 31................................... $ 7,734 $ 12,167 $ 4,441 ------------------------------------------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Income taxes.......................................... $ 90,649 $ 25,731 $ 31,846 ------------------------------------------ Interest expense on debt.............................. $ 21,675 $ 21,170 $ 20,926 ------------------------------------------ Interest expense on municipal investment contracts.... $ 148,526 $ 124,797 $ 85,540 ------------------------------------------ Cash received during the year for: Income taxes.......................................... $ -- $ 8,843 $ 1,167 - --------------------------------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements. 33 AMBAC 1996 ANNUAL REPORT ================================================================================ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ (Dollars in Thousands, Except Per Share Amounts) NOTE 1 Background AMBAC Inc. (the "Company") is a holding company that provides through its affiliates financial guarantee insurance and financial services to clients in both the public and private sectors. The Company's principal operating subsidiary, AMBAC Indemnity Corporation ("AMBAC Indemnity"), a leading insurer of municipal and structured finance obligations, has been assigned triple-A claims-paying ability ratings, the highest ratings available from Moody's Investors Service, Inc., Standard & Poor's Ratings Group, Fitch Investors Service, L.P., and Nippon Investors Service, Inc. AMBAC Inc.'s Financial Services Division provides investment contracts, interest rate swaps and investment management and advisory services principally to states, municipalities, municipal authorities and hospitals and health organizations. Prior to 1995, the Company and AMBAC Indemnity combined owned approximately 96% of HCIA Inc. ("HCIA"), a leading health care information content company. As such, HCIA's results of operations were reported as a separate industry segment. During 1995, the Company reduced its ownership equity in HCIA to approximately 46%, and consequently stopped consolidating its investment in HCIA and reporting HCIA's results as a separate industry segment. In May 1996, the Company sold its remaining holdings in HCIA. On December 31, 1996, the Company acquired substantially all of the assets of Cadre Financial Services, Inc. ("Cadre") for approximately $20,000 in Company stock and cash. Cadre is a provider of cash management and investment advisory services to local school districts, hospitals and health organizations and municipalities. At December 31, 1996, Cadre was providing investment administration services for approximately 2,600 clients with approximately $5,900,000 in assets. Included in the assets under administration at December 31, 1996, were approximately $1,900,000 of assets for which Cadre provides direct investment advisory services. As the transaction was consummated at the end of business on December 31, 1996, no results of operations from the acquisition are reflected in the Consolidated Statements of Operations. The acquisition of Cadre resulted in goodwill of $20,010, included in Other Assets, which is being amortized over 15 years on a straight-line basis. On August 8, 1996, the Company acquired a controlling equity interest in AMBAC Connect Inc. ("ACI"), the successor to Advanced Procurement Systems, Inc., for $2,400 in cash. The Company also invested $5,000 in cumulative preferred stock of ACI. ACI develops and markets software for governmental procurement applications. The acquisition of ACI resulted in goodwill of approximately $2,400, included in Other Assets, which is being amortized over 10 years on a straight-line basis. Both transactions were accounted for using the purchase method. The pro forma results of operations for the years ended December 31, 1996 and 1995, assuming Cadre and ACI had been acquired as of January 1, 1995, would not have been significantly different from those presented in the Consolidated Statements of Operations. NOTE 2 Significant Accounting Policies The accompanying consolidated financial statements have been prepared on the basis of generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant accounting policies of AMBAC Inc. and its subsidiaries (sometimes collectively referred to as the "Company") are as described below: Consolidation: The consolidated financial statements include the accounts of AMBAC Inc. and its subsidiaries. All significant intercompany balances have been eliminated. 34 AMBAC 1996 ANNUAL REPORT Net Income Per Common Share: Net income per common share is based on the weighted average number of shares outstanding during the year. The effects of common stock equivalents on net income per share calculations are not significant. Investments: The Company's investment portfolio is accounted for on a trade-date basis and consists entirely of investments in debt securities that are considered available-for-sale and are carried at fair value. Fair value is based on quotes obtained by the Company from independent market sources. Short-term investments are carried at cost, which approximates fair value. Unrealized gains and losses, net of deferred income taxes, are included as a separate component of stockholders' equity and are computed using amortized cost as the basis. For purposes of computing amortized cost, premiums and discounts are accounted for using the interest method. For bonds purchased at a price below par value, discounts are accreted over the remaining term of the securities. For bonds purchased at a price above par value which have call features, premiums are amortized to the most likely call dates as determined by management. For premium bonds which do not have call features, such premiums are amortized over the remaining terms of the securities. Premiums and discounts on mortgage- and asset-backed securities are adjusted for the effects of actual and anticipated prepayments. Realized gains and losses on the sale of investments are determined on the basis of specific identification. Securities Purchased Under Agreements to Resell: Securities purchased under agreements to resell are collateralized financing transactions, and are recorded at their contracted resale amounts, plus accrued interest. The Company takes possession of the collateral underlying those agreements and monitors its market value on a daily basis and, when necessary, requires prompt transfer of additional collateral to reflect current market value. Obligations Under Municipal Investment Contracts: Obligations under municipal investment contracts and municipal investment repurchase contracts are recorded as liabilities on the consolidated balance sheet at the face value of the contract, adjusted for draws paid and interest credited to the account. Unsettled contracts are accrued on a trade-date basis on the consolidated balance sheet at the time of commitment. Interest expense is computed based upon daily outstanding settled liability balances at rates and periods specified in the contracts and is included as a component of financial services operating income. Premium Revenue Recognition: Premiums for municipal new issue and secondary market policies are: (i) generally computed as a percentage of principal and interest insured; (ii) typically collected in a single payment at policy inception date; and (iii) are earned pro rata over the period of risk. Premiums for structured finance policies can be computed as a percentage of either principal or principal and interest insured. The timing of the collection of structured finance premiums varies among individual transactions. For policies where premiums are collected in a single payment at policy inception date, premiums are earned pro rata over the period of risk. For policies with premiums that are collected periodically (i.e., monthly, quarterly or annually), premiums are reflected in income pro rata over the period covered by the premium payment. When an AMBAC Indemnity-insured new or secondary market issue has been refunded or called, the remaining unearned premium is generally earned at that time, as the risk to AMBAC Indemnity is considered to have been eliminated. Losses and Loss Adjustment Expenses: The liability for losses and loss adjustment expenses consists of the Active Credit Reserve ("ACR") and case basis loss and loss adjustment expense reserves. The development of the ACR is based upon estimates of the ultimate aggregate losses inherent in the obligations insured. When losses occur (actual monetary defaults or defaults which are imminent on insured obligations), case basis loss reserves are established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default and estimated expenses associated with settling the claims, less estimated recoveries under salvage or subrogation rights. All or part of case basis loss reserves are allocated from any ACR available for such insured obligation. 35 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Dollars in Thousands,Except Per Share Amounts) AMBAC Indemnity's management believes that the reserves for losses and loss adjustment expenses are adequate to cover the ultimate net cost of claims, but the reserves are necessarily based on estimates and there can be no assurance that the ultimate liability will not exceed such estimates. Deferred Acquisition Costs: Certain costs incurred which vary with, and are primarily related to, the production of business have been deferred. These costs include direct and indirect expenses related to underwriting, marketing and policy issuance, rating agency fees and premium taxes, net of reinsurance ceding commissions. The deferred acquisition costs are being amortized over the periods in which the related premiums are earned, and such amortization amounted to $12,553, $10,183 and $9,348 for 1996, 1995 and 1994, respectively. Deferred acquisition costs, net of such amortization, amounted to $11,592, $10,845 and $20,757 for 1996, 1995 and 1994, respectively. Depreciation and Amortization: Depreciation of furniture and fixtures and electronic data processing equipment is provided over the estimated useful lives of the respective assets using the straight-line method. Amortization of leasehold improvements and intangibles, including certain computer software licenses, is provided over the estimated useful lives of the respective assets using the straight-line method. Interest Rate Contracts: Interest Rate Contracts Held for Purposes Other Than Trading:The Company uses interest rate contracts for hedging purposes as part of its overall interest rate risk management. Gains and losses on interest rate futures and options contracts that qualify as accounting hedges of existing assets or liabilities are included in the carrying amounts and amortized over the remaining lives of the assets and liabilities as an adjustment to interest income or expense. When the hedged asset is sold or the hedged liability is settled, the unamortized gain or loss on the related hedge is recognized in income. Gains and losses on interest rate contracts that do not qualify as accounting hedges are recognized in current period income. The Company accounts for its interest rate futures contracts in accordance with the provisions of Statement of Financial Accounting Standards No. 80, "Accounting for Futures Contracts" ("Statement 80"). Statement 80 permits hedge accounting for interest rate futures contracts when the item to be hedged exposes the Company to price or interest rate risk, and the futures contract effectively reduces that exposure and is designated as a hedge. Interest rate futures contracts held for purposes other than trading are used primarily to hedge interest-sensitive assets and liabilities. Interest rate futures contracts are designated at inception as a hedge to specific assets and liabilities. Interest rate swaps that are linked with existing liabilities are accounted for as a hedge of those liabilities, using the accrual method as an adjustment to interest expense. Interest rate swaps that are linked with existing assets classified as available for sale are accounted for as hedges of those assets, using the accrual method as an adjustment to interest income, with unrealized gains and losses included in stockholders' equity, net of tax. Interest rate risk is managed through the linkage of the interest rate swaps, which synthetically changes the nature of the underlying asset or liability (for example, from a fixed to floating interest rate obligation). Interest Rate Contracts Held for Trading Purposes: The Company, in connection with its market-making activities as a provider of interest rate swaps to states, municipalities, municipal authorities and other entities in connection with their financings, uses interest rate contracts which are classified as held for trading purposes. Interest rate contracts are recorded on trade date at fair value. Changes in fair value are recorded as a component of financial services operating income. The fair value of interest rate swaps is determined through the use of valuation models. The portion of the interest rate swap's initial fair value that reflects credit considerations, ongoing servicing, and transaction hedging costs is recognized over the life of the interest rate swap, as an adjustment to financial services operating income. Interest rate swaps are recorded on a gross basis; assets and liabilities are netted by customer only when a legal right of set-off exists. 36 AMBAC 1996 ANNUAL REPORT Income Taxes: The Company, as common parent, files a consolidated Federal income tax return with its subsidiaries. In accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. The Internal Revenue Code permits municipal bond insurance companies to deduct from taxable income, subject to certain limitations, the amounts added to the statutory mandatory contingency reserve during the year. The deduction taken is allowed only to the extent that U.S. Treasury noninterest-bearing tax and loss bonds are purchased at their par value prior to the original due date of the Company's consolidated Federal tax return and held in an amount equal to the tax benefit attributable to such deductions. The amounts deducted must be included in taxable income when the contingency reserve is released, at which time the Company may redeem the tax and loss bonds to satisfy the additional tax liability. The purchases of tax and loss bonds are recorded as payments of Federal income taxes and are not reflected in the Company's current tax provision. Postretirement and Postemployment Benefits: The Company provides various postretirement and postemployment benefits, including pension, and health and life benefits covering substantially all employees who meet certain age and service requirements. The Company accounts for these benefits under the accrual method of accounting. Amounts related to the defined benefit pension plan and postretirement health benefits are charged based on actuarial determinations. Stock Compensation Plans: In 1991, the Company adopted the AMBAC Inc. 1991 Stock Incentive Plan. Under this plan, awards are granted to eligible employees of the Company and its subsidiaries in the form of incentive stock options or other stock-based awards. Effective in 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"). Statement 123 applies to all stock-based employee compensation plans (except employee stock ownership plans) in which an employer grants shares of its stock or other equity instruments to employees. Statement 123 permits a company to choose either the fair value based method of accounting as defined in the Statement or the intrinsic value based method of accounting as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), for its stock-based compensation plans. Companies electing the accounting requirements under APB 25 must also make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company has elected to account for its plans under APB 25. The adoption of Statement 123 had no effect on the Company's results of operations. Reclassifications: Certain reclassifications have been made to prior years' amounts to conform to the current year's presentation. NOTE 3 Investments The amortized cost and estimated fair value of investments in debt securities at December 31, 1996 and 1995 were as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Fair 1996 Cost Gains Losses Value ----------------------------------------------- Municipal obligations .......... $1,897,518 $ 87,616 $ 2,223 $1,982,911 Corporate securities ........... 939,312 33,943 9,365 963,890 U.S. Government obligations .... 102,774 1,363 1,707 102,430 Mortgage- and asset-backed securities (includes U.S. .... Government Agency obligations) 2,035,719 8,882 9,486 2,035,115 Other .......................... 116,205 -- 9 116,196 ----------------------------------------------- $5,091,528 $131,804 $ 22,790 $5,200,542 - ----------------------------------------------------------------------------------
Gross Gross Estimated Amortized Unrealized Unrealized Fair 1995 Cost Gains Losses Value - ---------------------------------------------------------------------------------- Municipal obligations .......... $1,563,389 $ 98,942 $ 2,428 $1,659,903 Corporate securities ........... 764,179 67,618 3,737 828,060 U.S. Government obligations .... 219,250 8,796 621 227,425 Mortgage- and asset-backed securities (includes U.S. .... Government Agency obligations) 1,535,973 18,058 4,515 1,549,516 Other .......................... 176,689 -- -- 176,689 ----------------------------------------------- $4,259,480 $193,414 $ 11,301 $4,441,593 - ----------------------------------------------------------------------------------
37 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Dollars in Thousands,Except Per Share Amounts) The amortized cost and estimated fair value of debt securities at December 31, 1996, by contractual maturity, were as follows:
Amortized Estimated 1996 Cost Fair Value - -------------------------------------------------------------------------------- Due in one year or less ........................ $ 140,921 $ 141,028 Due after one year through five years .......... 344,615 354,696 Due after five years through ten years ......... 279,108 290,987 Due after ten years ............................ 2,291,165 2,378,716 -------------------------- 3,055,809 3,165,427 Mortgage- and asset-backed securities .......... 2,035,719 2,035,115 -------------------------- $5,091,528 $5,200,542 - --------------------------------------------------------------------------------
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Net investment income from financial guarantee insurance operations comprised the following:
1996 1995 1994 - -------------------------------------------------------------------------------- Bonds .......................... $ 139,410 $ 127,864 $ 116,272 Short-term investments ......... 7,999 5,670 3,300 ----------------------------------------- Total investment income ...... 147,409 133,534 119,572 Investment expense ............. (2,468) (2,485) (2,460) ----------------------------------------- Net investment income ........ $ 144,941 $ 131,049 $ 117,112 - -------------------------------------------------------------------------------
Financial guarantee insurance operations had gross realized gains of $19,236, $27,786 and $26,514 for 1996, 1995 and 1994, respectively, and gross realized losses of $39,767, $27,609 and $39,900 for 1996, 1995 and 1994, respectively. Net investment income related to municipal investment contracts comprises gross investment income less related interest expense, and is a component of financial services operating income. For 1996, 1995 and 1994, gross investment income from municipal investment contracts was $165,196, $137,382 and $105,958, respectively, and the related interest expense was $154,484, $127,666 and $92,403, respectively. As of December 31, 1996, the Company did not have any investment concentrated in any single repayment source (excluding obligations of the U.S. Government and its agencies) with a fair value greater than 2.0% of its stockholders' equity. As of December 31, 1996 and 1995, the Company held securities subject to agreements to resell for $201,169 and $240,280, respectively. Such securities were held as collateral by the Company. The agreements had terms of less than 30 days. As of December 31, 1996 and 1995, the Company had pledged (or sold under agreements to repurchase) securities purchased under agreements to resell and investment securities to certain municipalities, with a fair value of $1,642,964 and $1,176,251, respectively, in connection with certain municipal investment contracts (including contracts structured as municipal investment repurchase contracts). Additionally, as of December 31, 1996 and 1995, investment securities with a fair value of $896 and $5,755, respectively, were pledged to futures brokers for required margin. NOTE 4 Reinsurance In the ordinary course of business, AMBAC Indemnity cedes exposures under various reinsurance contracts primarily designed to minimize losses from large risks and to protect capital and surplus. The effect of reinsurance on premiums written and earned was as follows:
Years Ended December 31, - ----------------------------------------------------------------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------------------- Written Earned Written Earned Written Earned - ----------------------------------------------------------------------------------------- Direct ...... $240,544 $155,883 $190,570 $125,559 $185,365 $134,760 Assumed ..... 6,664 3,126 2,756 1,349 4,541 1,325 Ceded ....... (37,793) (22,380) (28,606) (15,088) 2,815 (18,621) ------------------------------------------------------------------------ Net premiums $209,415 $136,629 $164,720 $111,820 $192,721 $117,464 - -----------------------------------------------------------------------------------------
The reinsurance of risk does not relieve the ceding insurer of its original liability to its policyholders. In the event that all or any of the reinsurers are unable to meet their obligations to AMBAC Indemnity under the existing reinsurance agreements, AMBAC Indemnity would be liable for such defaulted amounts. To minimize its exposure to significant losses from reinsurer insolvencies, AMBAC Indemnity evaluates the financial condition of its reinsurers and monitors concentrations of credit risk. There were no reinsurance receivables as of December 31, 1996 and 1995. As of December 31, 1996, prepaid reinsurance of approximately $139,629 was associated with AMBAC Indemnity's three largest reinsurers. As of December 31, 1996, AMBAC Indemnity held letters of credit and collateral amounting to approximately $159,129 from its reinsurers to cover liabilities ceded under the aforementioned reinsurance contracts. During 1995 and 1994, AMBAC Indemnity terminated reinsurance contracts, resulting in return premiums to AMBAC Indemnity of $18,141 and $30,482, respectively, of which $15,700 and $25,891 were recorded as an increase to the unearned premium reserve in 1995 and 1994, respectively, with the remainder recognized as revenue. 38 AMBAC 1996 ANNUAL REPORT NOTE 5 Losses and Loss Adjustment Expenses AMBAC Indemnity's liability for losses and loss adjustment expenses includes case basis loss and loss adjustment expense reserves and the ACR. Following is a summary of the activity in the case basis loss and ACR accounts and the components of the liability for losses and loss adjustment expenses:
1996 1995 1994 - ----------------------------------------------------------------------------------------- Case basis loss and loss adjustment expense reserves: Balance at January 1 ................................ $39,249 $38,892 $35,155 ---------------------------------- Incurred related to: Current year ...................................... 1,484 750 8,073 Prior years ....................................... (9,556) 2,650 (3,368) ---------------------------------- Total incurred ................................... (8,072) 3,400 4,705 ---------------------------------- Paid related to: Current year ...................................... 150 150 275 Prior years ....................................... 9,404 2,893 693 ---------------------------------- Total paid ....................................... 9,554 3,043 968 ---------------------------------- Balance at December 31 .............................. 21,623 39,249 38,892 ---------------------------------- Active credit reserve: Balance at January 1 .............................. 26,747 26,770 28,882 Net provision for losses .......................... 5,115 4,097 4,422 ACR transfers from (to) Case Reserves ............. 6,735 (4,120) (6,534) ---------------------------------- Balance at December 31 .............................. 38,597 26,747 26,770 ---------------------------------- Total ............................................. $60,220 $65,996 $65,662 - -----------------------------------------------------------------------------------------
The terms "current year" and "prior years" in the foregoing table refer to the year in which case basis loss reserves were established. NOTE 6 Stockholders' Equity The Company is authorized to issue 50,000,000 shares of Common Stock, par value $0.01 per share, of which 35,340,192 were issued as of December 31, 1996. The Company is also authorized to issue 20,000,000 shares of Class A Common Stock, par value $0.01 per share, none of which was issued and outstanding as of December 31, 1996, and 4,000,000 shares of preferred stock, $0.01 par value per share, none of which was issued and outstanding as of December 31, 1996. Dividends declared per common share amounted to $0.615, $0.555 and $0.495 in 1996, 1995 and 1994, respectively. The Board of Directors of the Company (the "Board") has authorized the establishment of a stock repurchase program which permits the repurchase of up to 3,000,000 shares of the Company's Common Stock. As of December 31, 1996, approximately 1,061,000 shares had been repurchased under this program for an aggregate amount of $49,571. Stockholder Rights Plan: In January 1996, the Company adopted a Stockholder Rights Plan under which stockholders received one Right for each share of Common Stock owned. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a purchase price of $190 per share. The Rights generally detach and become exercisable when any person or group acquires 20% or more (or announces a tender offer for 20% or more) of the Company's Common Stock, at which time each Right (other than those held by the acquiring company) will entitle the holder to receive that number of shares of Common Stock of the Company with a value of two times the exercise price of the Right. If the Company is acquired in a merger or other business combination transaction in which the Company is not the surviving corporation or 50% or more of the Company's assets, cash flow or earning power is sold or transferred, each Right will entitle the holder to receive that number of shares of stock of the acquiring company having a value equal to two times the exercise price of the Right. The Rights, which expire on January 31, 2006, are redeemable in whole, but not in part, by action of the Board of Directors at a price of $.01 per Right at any time prior to their becoming exercisable. NOTE 7 Commitments and Contingencies The Company is responsible for leases on the rental of office space, principally in New York City and Westport, CT. The lease agreements, which expire periodically through September 2014, contain provisions for scheduled periodic rent increases and are accounted for as operating leases. An estimate of future net minimum lease payments in each of the next five years ending December 31, and the periods thereafter, is as follows:
Amount - -------------------------------------------------------------------------------- 1997 .................................................... $4,027 1998 .................................................... 4,311 1999 .................................................... 4,502 2000 .................................................... 4,399 2001 .................................................... 4,338 All later years ......................................... 52,837 ------- $74,414
Rent expense for the aforementioned leases amounted to $3,862, $3,461 and $2,859 for the years ended December 31, 1996, 1995 and 1994, respectively. 39 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Dollars in Thousands,Except Per Share Amounts) NOTE 8 Insurance Regulatory Restrictions AMBAC Indemnity is subject to insurance regulatory requirements of the States of Wisconsin and New York and the other jurisdictions in which it is licensed to conduct business. AMBAC Indemnity's ability to pay dividends is generally restricted by law and subject to approval by the Office of the Commissioner of Insurance of the State of Wisconsin (the "Wisconsin Commissioner"). Wisconsin insurance law restricts the payment of dividends in any 12-month period without regulatory approval to the lesser of (a) 10% of policyholders' surplus as of the preceding December 31 and (b) the greater of (i) statutory net income for the calendar year preceding the date of dividend, minus realized capital gains for that calendar year and (ii) the aggregate of statutory net income for three calendar years preceding the date of the dividend, minus realized capital gains for those calendar years and minus dividends paid or credited within the first two of the three preceding calendar years. AMBAC Indemnity paid cash dividends of $40,000, $40,000 and $36,000 on its common stock in 1996, 1995 and 1994, respectively. In addition, on April 30, 1996, AMBAC Indemnity, in conjunction with the sale of the Company's remaining holdings in HCIA common stock, delivered to the Company (in the form of an extraordinary dividend) its 2,378,672 shares of HCIA common stock, at fair value. The Wisconsin Commissioner approved such dividend. As a result, any dividends paid by AMBAC Indemnity to the Company through June 30, 1997, require pre-approval from the Wisconsin Commissioner. The Wisconsin Commissioner has stated to AMBAC Indemnity management that it does not foresee any reason pre-approval of anticipated common stock dividends paid through June 30, 1997, would not be given. Anticipated common stock dividends paid thereafter and through year-end 1997, will not require such pre-approval. The New York Financial Guarantee Insurance Law establishes single risk limits applicable to all obligations issued by a single entity and backed by a single revenue source. Under the limit applicable to municipal bonds, the insured average annual debt service for a single risk, net of reinsurance and collateral, may not exceed 10% of qualified statutory capital, which is defined as the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal bonds attributable to any single risk, net of reinsurance and collateral, is limited to 75% of AMBAC Indemnity's qualified statutory capital. Additional single risk limits, which generally are more restrictive than the municipal bond single risk limit, are also specified for several other categories of insured obligations. Statutory capital and surplus was $899,023 and $862,976 at December 31, 1996 and 1995, respectively. Qualified statutory capital was $1,466,560 and $1,358,769 at December 31, 1996 and 1995, respectively. Statutory net income was $222,810, $142,541 and $116,238 for 1996, 1995 and 1994, respectively. Statutory capital and surplus differs from stockholders' equity determined under GAAP principally due to statutory accounting rules that treat loss reserves, premiums earned, policy acquisition costs and deferred income taxes differently. NOTE 9 Income Taxes The Company's provision for income taxes is comprised of the following:
1996 1995 1994 - -------------------------------------------------------------------------------- Current taxes .................. $94,392 $33,286 $22,960 Deferred taxes ................. 4,797 13,293 15,854 --------------------------------------- $99,189 $46,579 $38,814 - --------------------------------------------------------------------------------
The total effect of income taxes on income and stockholders' equity for the years ended December 31, 1996 and 1995 was as follows:
1996 1995 - -------------------------------------------------------------------------------- Total income taxes charged to income ................... $99,189 $46,579 --------------------- Income taxes charged (credited) to stockholders' equity: Unrealized (losses) gains on bonds ................... (28,108) 127,038 Unrealized gain on investment in affiliate ........... -- 7,730 Other ................................................ (2,282) (677) --------------------- Total (credited) charged to stockholders' equity .... (30,390) 134,091 --------------------- Total effect of income taxes ........................... $68,799 $180,670 - --------------------------------------------------------------------------------
The tax provisions in the accompanying consolidated statements of operations reflect effective tax rates differing from prevailing Federal corporate income tax rates. The following is a reconciliation of these differences: 40 AMBAC 1996 ANNUAL REPORT
1996 1995 1994 - ------------------------------------------------------------------------------------------- Computed expected tax at statutory rate $131,427 35.0% $74,961 35.0% $62,972 35.0% Increases (reductions) in expected tax resulting from: Tax-exempt interest ... (30,760) (8.2) (28,379) (13.3) (26,441) (14.6) Other, net .......... (1,478) (0.4) (3) -- 2,283 1.2 --------------------------------------------------------------- Income tax expense .... $99,189 26.4% $46,579 21.7% $38,814 21.6% - -------------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December 31, 1996 and 1995 are presented below:
1996 1995 - -------------------------------------------------------------------- Deferred tax liabilities: Contingency reserve ....................... $ 76,805 $ 76,805 Unrealized gains on bonds ................. 30,150 58,258 Deferred acquisition costs ................ 32,974 28,917 Unearned premiums ......................... 28,060 22,167 Unrealized gain on investment in affiliate -- 7,730 Investments ............................... 60 3,638 Other ..................................... 1,250 1,904 ------------------ Total deferred tax liabilities ........... 169,299 199,419 ------------------ Deferred tax assets: Tax and loss bonds ........................ 63,871 63,871 Loss reserves ............................. 13,512 9,631 Alternative minimum tax credit carryforward -- 12,272 Amortization and Depreciation ............. 4,836 2,870 Compensation .............................. 2,884 2,672 Other ..................................... 4,110 4,406 ------------------ Sub-total deferred tax assets ............ 89,213 95,722 Valuation allowance ....................... -- -- ------------------ Total deferred tax assets ................ 89,213 95,722 ------------------ Net deferred tax liabilities ............. $ 80,086 $103,697 - -------------------------------------------------------------------
The Company believes that no valuation allowance is necessary in connection with the deferred tax assets. NOTE 10 Employee Benefits Pensions: The Company has a defined benefit pension plan covering substantially all employees of the Company and its subsidiaries. The benefits are based on years of service and the employee's compensation during the last five years of employment. The Company's funding policy is to contribute annually the maximum amount that can be deducted for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service-to-date but also for those expected to be earned in the future. The actuarial present value of the benefit obligations shown in the following table sets forth the plan's funded status and amounts recognized by the Company as of December 31, 1996 and 1995.
1996 1995 - ------------------------------------------------------------------------------- Accumulated benefit obligation, including vested benefits of $6,282 and $6,049, respectively ........... ($6,979) ($6,788) --------------------- Projected benefit obligation for service rendered to date (8,189) (7,800) Plan assets at fair value, primarily listed stocks, commingled funds and fixed income securities .......... 8,153 7,054 --------------------- Unfunded projected benefit .............................. (36) (746) Unrecognized prior service cost ......................... (1,619) (1,784) Unrecognized net loss ................................... 885 1,906 Unrecognized net transition asset ....................... (9) (12) --------------------- Pension liability included in other liabilities ......... ($ 779) ($ 636) - --------------------------------------------------------------------------------
Net pension costs for 1996, 1995 and 1994 included the following components:
1996 1995 1994 - ------------------------------------------------------------------------ Service cost ............................... $ 674 $ 541 $ 558 Interest cost on expected benefit obligation 539 456 386 Actual return on plan assets ............... (957) (1,333) 30 Net amortization and deferral .............. 263 760 (547) ------------------------- Net periodic pension cost .................. $ 519 $ 424 $ 427 - ------------------------------------------------------------------------
The weighted-average discount rate used in the determination of the actuarial present value for the projected benefit obligation was 7.50% and 7.25% for 1996 and 1995, respectively. The expected long-term rate of return on assets was 9.25% for both 1996 and 1995. The rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 5.0% for both 1996 and 1995. Substantially all employees of the Company and its subsidiaries are covered by a defined contribution plan (the "Savings Incentive Plan"), for which contributions and costs are determined as 6% of each covered employee's base salary, plus a matching company contribution of 50% on contributions up to 6% of base salary made by eligible employees to the plan. The total cost of the Savings Incentive Plan was $1,680, $1,555 and $1,292 in 1996, 1995 and 1994, respectively. Annual Incentive Plan: The Company has an annual incentive plan which provides for awards to key officers and employees based upon predetermined criteria. The cost of the plan for the years ended December 31, 1996, 1995 and 1994 amounted to $10,822, $8,860 and $9,880, respectively. Postretirement Health Care and Other Benefits: AMBAC Indemnity provides certain medical and life insurance benefits for retired employees and eligible dependents. All plans are contributory. None of the plans is currently funded. 41 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Dollars in Thousands,Except Per Share Amounts) Postretirement benefits expense was $220, $168 and $176 in 1996, 1995 and 1994, respectively. The unfunded accumulated postretirement benefit obligation was $1,526 and the accrued postretirement liability was $1,524 as of December 31, 1996. The assumed weighted average health care cost trend rates range from 8.5% in 1996, decreasing ratably to 5.5% in 2001, and remaining at that level thereafter. Increasing the assumed health care cost trend rate by one percentage point in each future year would increase the accumulated postretirement benefit obligation at December 31, 1996 by $194 and the 1996 benefit expense by $40. The weighted average discount rate used to measure the accumulated postretirement benefit obligation and 1996 expense was 7.50%. NOTE 11 Insurance in Force The par amount of bonds insured by AMBAC Indemnity, net of reinsurance, was $131,497,000 and $110,997,000 at December 31, 1996 and 1995, respectively. As of December 31, 1996 and 1995, AMBAC Indemnity's insured portfolio was diversified by type of insured bond as shown in the following table:
Net Par Amount Outstanding -------------------------- (Dollars in Millions) 1996 1995 - -------------------------------------------------------------------------------- Municipal finance: General obligation ............................... $ 31,863 $ 30,546 Lease and tax-backed revenue ..................... 25,366 18,780 Utility revenue .................................. 22,780 21,053 Health care revenue .............................. 13,521 12,553 Transportation revenue ........................... 6,891 6,293 Investor-owned utilities ......................... 5,551 4,497 Higher education ................................. 4,745 3,973 Housing revenue .................................. 4,497 3,577 Student loans .................................... 3,439 3,769 Other ............................................ 484 483 -------------------------- Total municipal finance ......................... 119,137 105,524 -------------------------- Structured finance: Domestic: Mortgage-backed and home equity ................. 5,263 1,901 Asset-backed .................................... 1,329 1,213 Other ........................................... 1,440 124 -------------------------- Total domestic structured finance ............. 8,032 3,238 -------------------------- International: Asset-backed .................................... 2,530 1,382 Other ........................................... 1,798 853 -------------------------- Total international structured finance ........ 4,328 2,235 -------------------------- Total structured finance ...................... 12,360 5,473 -------------------------- $131,497 $110,997 - --------------------------------------------------------------------------------
As of December 31, 1996, California was the state with the highest aggregate net par amount in force, accounting for 15.6% of the total, and the highest single insured risk represented 1.0% of aggregate net par amount insured. AMBAC Indemnity's direct insurance in force (principal and interest) was $268,870,000 and $235,118,000 at December 31, 1996 and 1995, respectively. Net insurance in force (after giving effect to reinsurance) was $227,235,000 and $199,078,000 as of December 31, 1996 and 1995, respectively. NOTE 12 Financial Instruments Held For Purposes Other Than Trading Financial instruments with off-balance-sheet risk: In the normal course of business, the Company becomes a party to various financial transactions to reduce its exposure to fluctuations in interest rates. These financial instruments include interest rate swaps, exchange traded interest rate futures contracts and purchased interest rate options. The notional amounts of the Company's off-balance-sheet financial instruments which are held for purposes other than trading were as follows:
As of December 31, 1996 1995 - -------------------------------------------------------------------------------- Interest rate futures contracts .............. $1,569,800 $1,171,600 Interest rate swaps .......................... 689,023 240,000 Purchased interest rate options .............. 32,200 15,000 - --------------------------------------------------------------------------------
Notional principal amounts are often used to express the volume of these transactions and do not reflect the extent to which positions may offset one another. These amounts do not represent the much smaller amounts potentially subject to risk. In the ordinary course of business, the Company, through its affiliates, manages a variety of risks, principally credit, market, liquidity, operational and legal. These risks are identified, measured and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. Credit risk relates to the ability of counterparties to perform according to the terms of their contractual commitments. Credit risk is calculated based on the current replacement cost or fair value of the Company's financial instruments. The gross replacement cost of these financial instruments is the positive fair value of all transactions with a counterparty, excluding the effects of netting or collateral arrangements, and was approximately $2,000 and $5,000 as of December 31, 1996 and 1995, respectively. The Company executes these transactions with a diverse base of counterparties in order to minimize concentrations of credit risk. Various procedures and controls are in place to monitor the credit risk associated with municipal investment contracts and interest rate swaps. These include the initial credit approval process, minimum 42 AMBAC 1996 ANNUAL REPORT credit rating requirements and the continuous monitoring of credit exposure. The Company also has credit risk associated with its investment portfolio. These risks are controlled through strict compliance with written investment policy guidelines. These investment policy guidelines include a pre-established set of criteria including minimum credit ratings, restrictions on the nature of investments and single credit concentration limits. Market risk relates to the impact of value changes of the Company's assets and hedges on equity. The principal market risk is interest rate risk. An independent risk management group is involved in setting and monitoring risk limits and in the application of risk measurement methodologies. The estimation of potential losses arising from adverse changes in market conditions is a key element in managing market risk. The Company utilizes various models and stress testing to manage interest rate risk. This process includes frequent analyses of both parallel and non-parallel shifts in yield curve risk. Liquidity risk relates to the possible inability to satisfy contractual obligations when due. This risk is present in municipal investment contracts and interest rate swaps and futures contracts. The Company manages liquidity risk by matching the effective duration of its invested assets, including hedges, with the effective duration of its municipal investment contract liabilities. Additionally, the Company's policy is to maintain a minimum level of cash and short-term liquid assets equivalent to a specified percentage of its municipal investment contract liabilities outstanding. Operational risk relates to the potential for loss caused by a breakdown in information, communication and settlement systems. The Company mitigates operational risk by maintaining a comprehensive system of internal controls. This includes the establishment of systems and procedures to monitor transactions and positions, documentation and confirmation of transactions and ensuring compliance with regulations. Legal risk relates to the uncertainty of the enforceability, through legal or judicial processes, of the obligations of the Company's counterparties, including contractual provisions intended to reduce credit exposure by providing for the offsetting or netting of mutual obligations. The Company seeks to remove or minimize such uncertainties through continuous consultation with internal and external legal advisers to analyze and understand the nature of legal risk, to improve documentation and to strengthen transaction structure. As discussed in Note 2, interest rate futures contracts held for purposes other than trading are used primarily to hedge price or interest rate risk inherent in the portfolio of interest-sensitive assets and liabilities. Interest rate swaps held for purposes other than trading are used to manage interest rate risk by synthetically changing the nature of specific assets or liabilities. Interest rate futures contracts are purchased to hedge interest rate risk inherent in fixed rate liabilities. Interest rate futures contracts are sold to hedge interest rate risk inherent in fixed rate investment securities. At December 31, 1996 and 1995, interest rate futures contracts with an outstanding notional amount of $1,091,900 and $1,006,500, respectively, were designated as hedges of fixed rate liabilities. Additionally, at December 31, 1996 and 1995, interest rate futures contracts with an outstanding notional amount of $477,900 and $165,100, respectively, were designated as hedges of fixed rate investment securities. Interest rate swaps which require the Company to pay the fixed rate are used primarily to hedge fixed rate investment securities. Interest rate swaps which require the Company to receive the fixed rate are used primarily to hedge fixed rate liabilities. The table below summarizes, for each major type of swap, the weighted-average fixed rate paid or received on the respective notional amounts outstanding. Notional amounts are used to calculate the contractual payments to be exchanged under these contracts.
Maturing after December 31, - --------------------------------------------------------------------------------------------------------------------------- 1997 1998 1999 2000 2001 Thereafter - --------------------------------------------------------------------------------------------------------------------------- Pay fixed swaps: Notional amount .................. $ 192,046 $ 226,528 $ 299,775 $ 202,368 $ 161,145 $ 61,191 Weighted-average fixed rate ...... 6.00% 6.05% 6.98% 7.02% 6.93% 7.04% Receive fixed swaps: Notional amount .................. $ 169,776 $ 138,556 $ 137,922 $ 137,271 $ 136,602 $ 146,352 Weighted-average fixed rate ...... 6.25% 6.45% 6.45% 6.45% 6.45% 6.54% Range of implied floating interest rates ................. 5.90% 5.99% 6.52% 6.60% 6.84% to 6.09% to 6.48% to 6.69% to 6.88% to 6.90% - ---------------------------------------------------------------------------------------------------------------------------
43 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Dollars in Thousands,Except Per Share Amounts) The floating rate side of the Company's interest rate swaps is based on several indices, primarily one-month, three-month and six-month LIBOR. The floating rates shown above reflect the range of the implied forward LIBOR yield curve for those indices, as of December 31, 1996. Fair values of financial instruments held for purposes other than trading: The following fair value amounts were determined by the Company using independent market information when available, and appropriate valuation methodologies when market quotes were not available. In cases where specific market quotes are unavailable, interpreting market data and estimating market values require considerable judgment by management. Accordingly, the estimates presented are not necessarily indicative of the amount the Company could realize in a current market exchange. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Investments: The fair values of bonds are based on quoted market prices or dealer quotes. Short-term investments and cash: The fair values of short-term investments and cash are assumed to equal amortized cost. Securities purchased under agreements to resell: The fair value of securities purchased under agreements to resell is assumed to approximate carrying value. Investment in affiliate: At December 31, 1995, the fair value of the Company's investment in HCIA was based on the quoted market price of HCIA common stock. Debentures: The fair value of the debentures is based on the quoted market prices and dealer quotes. Municipal investment contracts and municipal investment repurchase contracts: The fair value of the liability for municipal investment contracts and repurchase agreements (including accrued interest) is estimated based upon valuation models using rates currently offered for contracts of similar remaining maturities. Interest rate contracts: Fair values of off-balance-sheet interest rate contracts (futures, swaps and interest rate options) are based on quoted market and dealer prices, current settlement values, or pricing models. Liability for net financial guarantees written: The fair value of the liability for those financial guarantees written related to new issue and secondary market exposures is based on the estimated cost to reinsure those exposures at current market rates, which amount consists of the current unearned premium reserve, less an estimated ceding commission thereon. Certain other financial guarantee insurance policies have been written on an installment basis, where the future premiums to be received by the Company are determined based on the outstanding exposure at the time the premiums are due. The fair value of AMBAC Indemnity's liability under its installment premium policies is measured using the present value of estimated future installment premiums, less an estimated ceding commission. The estimate of the amounts and timing of the future installment premiums is based on contractual premium rates, debt service schedules and expected run-off scenarios. This measure is used as an estimate of the cost to reinsure AMBAC Indemnity's liability under these policies. The carrying amount and estimated fair value of these financial instruments are presented below:
As of December 31, 1996 1995 - ----------------------------------------------------------------------------------- Estimated Estimated Carrying Fair Carrying Fair (Dollars in Millions) Amount Value Amount Value - ----------------------------------------------------------------------------------- Financial assets: Investments ............................... $5,088 $ 5,088 $4,265 $4,265 Short-term investments .................... 113 113 177 177 Cash ...................................... 8 8 12 12 Securities purchased under agreements to resell .................... 201 201 240 240 Investment in affiliate ................... -- -- 45 194 Financial liabilities: Debentures ................................ 224 259 224 271 Municipal investment contracts and municipal investment repurchase contracts (including accrued interest) ....................... 2,778 2,775 2,446 2,486 Unrecognized financial instruments: Interest rate futures contracts ........... -- -- -- -- Interest rate swaps ....................... -- (1) -- 2 Purchased interest rate option ............ -- -- -- -- Liability for financial guarantees written: Direct .................................... -- 719 -- 655 Net of reinsurance ........................ -- 596 -- 543 Net installment premiums .................. -- 114 -- 80 - -----------------------------------------------------------------------------------
NOTE 13 Financial Instruments Held For Trading Purposes The Company, through its affiliate AMBAC Financial Services, Limited Partnership, is a provider of interest rate swaps to states, municipalities, municipal authorities and other entities in connection with their financings. The Company manages its business 44 AMBAC 1996 ANNUAL REPORT with the goal of being market neutral to changes in overall interest rates, while retaining basis risk, the relationship between changes in floating rate tax-exempt and floating rate taxable interest rates. If actual or projected floating rate tax-exempt interest rates rise in relation to floating rate taxable interest rates, the Company will experience an unrealized mark-to-market loss. Conversely, if actual or projected floating rate tax-exempt interest rates decline in relation to floating rate taxable interest rates, the Company will experience an unrealized mark-to-market gain. In the ordinary course of business, the Company manages a variety of risks, principally credit, market, liquidity, operational, and legal. These risks are identified, measured and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. Operational and legal risks related to financial instruments held for trading purposes are similar to those risks as described in Note 12. Credit risk relates to the ability of counterparties to perform according to the terms of their contractual commitments. Credit risk is calculated based on the current replacement cost or fair value of the Company's financial instruments. The Company executes these transactions with a diverse base of counterparties in order to minimize concentrations of credit risk. Various procedures and controls are in place to monitor the credit risk of interest rate swaps. These include the initial credit approval process, the establishment of credit limits, management approvals, and a process that ensures the continuous monitoring of credit exposure. Market risk relates to the impact of price changes on future earnings. This risk is a consequence of the Company's market-making activities in the municipal interest rate swap market. The principal market risk is basis risk, the relationship between changes in floating rate tax-exempt and floating rate taxable interest rates. Since the third quarter of 1995, all municipal interest rate swaps transacted contain provisions which are designed to protect the Company against certain forms of tax reform, thus mitigating its basis risk. An independent risk management group monitors trading risk limits and, together with senior management, is involved in the application of risk measurement methodologies. The estimation of potential losses arising from adverse changes in market relationships, known as "value-at-risk," is a key element in managing market risk. The Company has developed a value-at-risk methodology to estimate potential losses over a specified holding period and based on certain probabilistic assessments. The Company estimates value-at-risk utilizing historical short- and long-term interest rate volatilities and the relationship between changes in tax-exempt and taxable interest rates calculated on a consistent daily basis. For the years ended December 31, 1996 and 1995, the Company's value-at-risk, calculated at a ninety-nine percent confidence level, averaged approximately $1,389 and $1,358, respectively. The Company's value-at-risk ranged from a high of $2,585 to a low of $1,096 in 1996 and from a high of $2,131 to a low of $687 in 1995. Since no single measure can capture all dimensions of market risk, the Company bolsters its value-at-risk methodology by performing daily analyses of parallel and non-parallel shifts in yield curves and stress test scenarios which measure the potential impact of market conditions, however improbable, which might cause abnormal volatility swings or disruptions of market relationships. Liquidity risk relates to the possible inability to satisfy contractual obligations when due. This risk is present in swaps and in futures contracts used to hedge swaps. The Company manages liquidity risk by maintaining cash and cash equivalents, closely matching the dates swap payments are made and received, and limiting the amount of risk hedged by futures contracts. The following table summarizes information about the Company's financial instruments held for trading purposes as of December 31, 1996 and 1995:
Average Net Net Net Fair Value Carrying Estimated ------------------------- Notional Amount Fair Value Assets Liabilities Amount - -------------------------------------------------------------------------------------------------------------------------------- 1996: Interest rate swaps ........................ $12,133 $12,133 $44,241 $37,451 $2,341,660 Interest rate futures contracts ................................ -- -- -- -- 484,500 1995: Interest rate swaps ........................ $ 6,066 $ 6,066 $14,639 $13,663 $1,793,400 Interest rate futures contracts ................................ -- -- -- -- 569,800 - --------------------------------------------------------------------------------------------------------------------------------
The aggregate amount of net trading income recognized from financial instruments held for trading purposes was $10,579, $2,871 and $2,101 for 1996, 45 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Dollars in Thousands,Except Per Share Amounts) 1995 and 1994, respectively. Average net fair values were calculated based on average daily net fair values. The gross replacement cost of the Company's financial instruments held for trading purposes is the positive fair value of all transactions with a counterparty, excluding the effects of netting or collateral arrangements, and was approximately $42,000 and $52,000 as of December 31, 1996 and 1995, respectively. Net estimated fair value, after netting and collateral arrangements more accurately portrays the credit risk associated with the Company's financial instruments held for trading purposes. Notional principal amounts are often used to express the volume of these transactions and do not reflect the extent to which positions may offset one another. These amounts do not represent the much smaller amounts potentially subject to risk. NOTE 14 Long-Term Debt and Lines of Credit The carrying value of long-term debt was as follows:
December 31, 1996 1995 - -------------------------------------------------------------------------------- 9-3/8% Debentures, due 2011 .................. $149,344 $149,299 7-1/2% Debentures, due 2023 .................. 74,454 74,433 ------------------------- $223,798 $223,732 - --------------------------------------------------------------------------------
The Debentures due on February 1, 2011 were issued on August 8, 1991 in the principal amount of $150,000 and bear interest of 9-3/8%, payable on February 1 and August 1 of each year. The Debentures are noncallable and were sold at 99.4% of their principal amount at an effective yield of 9.44%. The Debentures due on November 1, 2023 were issued on May 11, 1993 in the principal amount of $75,000 and bear interest of 7-1/2%, payable on May 1 and November 1 of each year. The Debentures are noncallable and were sold at 99.171% of their principal amount at an effective yield of 7.57%. The Company uses an interest rate swap based on a notional value of $125,000 to synthetically manage a portion of its interest rate risk relative to its long-term debt. The Company and AMBAC Indemnity maintain a three-year revolving credit facility with two major international banks, as co-agents, for $100,000. As of December 31, 1996 and 1995, no amounts were outstanding under this credit facility, which expires in July 1998. AMBAC Indemnity has an agreement with a group of Aaa/AAA-rated international banks for a $350,000 credit facility, expiring in 2003. This facility is a seven-year stand-by irrevocable limited recourse line of credit, which was increased from $300,000 to $350,000 and extended for an additional year in December 1996. The line will provide liquidity to AMBAC Indemnity in the event claims from municipal obligations exceed specified levels. Repayment of any amounts drawn under the line will be limited primarily to the amount of any recoveries of losses related to policy obligations. As of December 31, 1996 and 1995, no amounts were outstanding under this line. NOTE 15 Obligations Under Municipal Investment Contracts Obligations under municipal investment contracts, including those structured in the form of repurchase contracts, are recorded on a trade-date basis. Certain obligations may be called at various times prior to maturity at the option of the counterparty. As of December 31, 1996 and 1995, the interest rates on these agreements ranged from 4.23% to 8.14% and 3.65% to 8.14%, respectively. As of December 31, 1996 and 1995, obligations under municipal investment contracts and municipal investment repurchase contracts were as follows:
1996 1995 - -------------------------------------------------------------------------------- Settled .......................... $2,721,291 $2,222,061 Unsettled ........................ 33,299 204,797 --------------------------------- $2,754,590 $2,426,858 - --------------------------------------------------------------------------------
Net payments due under settled investment contracts in each of the next five years ending December 31, and the periods thereafter, based on expected call dates, were as follows:
Principal Amount - -------------------------------------------------------------------------------- 1997 ................................................. $ 945,960 1998 ................................................. 677,213 1999 ................................................. 443,880 2000 ................................................. 43,234 2001 ................................................. 82,174 All later years ...................................... 528,830 ---------- $2,721,291 - --------------------------------------------------------------------------------
46 AMBAC 1996 ANNUAL REPORT NOTE 16 Common Stock Incentives The Company's stock incentive plan, the AMBAC Inc. 1991 Stock Incentive Plan (the "Plan"), provides for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock units, performance unit awards, stock purchase rights, or other stock or stock-based awards that are valued or determined by reference to the Common Stock. Options are exercisable and expire as specified at the time of grant. The cumulative number of shares subject to award is limited to a maximum of 10% of the number of shares outstanding on a fully diluted basis as of the immediately preceding fiscal quarter. The Plan also limits the number of shares available for grant in each year (as determined by formula). Based on the provisions of the Plan, there are approximately 650,000 shares available for grant in 1997. As of December 31, 1996, the maximum number of shares subject to award under the Plan was approximately 3,727,000 of which approximately 3,076,000 (net of cancellations) had previously been awarded. A summary of option activity is as follows:
1996 1995 1994 - ------------------------------------------------------------------------------------------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price - --------------------------- ------------- --------- ------------- ----------- ----------- Outstanding at beginning of year .... 2,070,412 $ 36.34 1,700,120 $ 34.60 1,266,852 $ 31.70 Granted ...... 482,075 $ 48.49 511,645 $ 39.57 517,620 $ 41.56 Exercised .... (360,862) $ 37.06 (121,248) $ 24.79 (19,580) $ 21.24 Forfeited .... (67,304) $ 43.74 (20,105) $ 41.59 (64,772) $ 33.53 ---------- ---------- ---------- Outstanding at end of year .... 2,124,321 $ 38.74 2,070,412 $ 36.34 1,700,120 $ 34.60 - ------------------------------------------------------------------------------------------------------ Exercisable .. 1,203,919 1,141,245 855,806 - ------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable - -------------------------------------------------------------------------------- Number Weighted Weighted Number Weighted Range of Outstanding Average Average Exercisable Average Exercise at December Remaining Exercise at December Exercise Prices 31, 1996 Contract Life Price 31, 1996 Price - -------------------------------------------------------------------------------- $20 to 32 450,155 5.3 $20.35 450,155 $20.35 $34 to 44 932,221 7.4 $40.25 488,444 $40.19 $45 to 62 741,945 6.5 $47.99 265,320 $47.09 ----------- --------- 2,124,321 1,203,919 - --------------------------------------------------------------------------------
The Company applies APB 25 and related Interpretations in accounting for its plans. Accordingly, since the fair value of the options at grant date equals the exercise price, no compensation cost has been recognized for its fixed stock option plan. Had compensation cost for the Company's stock-based compensation plan been determined consistent with Statement 123, the Company's net income and earnings per share for the years ended December 31, 1996 and 1995, would have been reduced to the pro forma amounts below:
1996 1995 - -------------------------------------------------------------------------------- Net Income: As reported ........................ $ 276,317 $ 167,595 Pro forma .......................... $ 273,528 $ 166,080 Earnings per share: As reported ........................ $ 7.90 $ 4.78 Pro forma .......................... $ 7.82 $ 4.73 - --------------------------------------------------------------------------------
The weighted-average fair value of options granted in 1996 and 1995 was $12.38 per share and $12.80 per share, respectively. The fair value of each option grant issued was estimated as of the date of the grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants in 1996 and 1995, respectively: dividend yield of 1.24% and 1.18%; expected volatility of 16.5% and 20.0%; risk-free interest rates of 6.2% and 7.2%; and expected lives of 5 years and 6 years. The pro forma amounts disclosed above are not likely to be representative of reported pro forma net income and earnings per share for future years because options vest over several years and additional awards are granted each year. NOTE 17 Segment Information As of December 31, 1996, the Company's products are reported in two industry segments, as follows: Financial guarantee insurance includes insurance of municipal and structured finance obligations. Financial services includes investment management and advisory services, the issuance of investment contracts, investment repurchase contracts and interest rate swaps principally to states, municipalities and municipal authorities. Prior to the sale of the Company's controlling portion in its health care information content subsidiary in August 1995, the Company reported a third industry segment called information services. Information services included information products and analytical services on the financial and operating performance of hospitals, nursing homes, retirement facilities and health maintenance organizations through on-line computer services and publications primarily to the hospital, health insurance and health care supplier markets. 47 AMBAC 1996 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (CONTINUED) (Dollars in Thousands, Except per Share amount) The following table is a summary of the operations by operating segment for the years ended December 31, 1996, 1995 and 1994:
Financial Adjustments Guarantee Financial Information Corporate and Insurance Services Services and Other Eliminations Consolidated - ------------------------------------------------------------------------------------------------------------------------------------ 1996: Revenues: Unaffiliated customers .............. $ 266,300 $ 22,156 $ -- $ 164,587 $ -- $ 453,043 Intersegment ........................ 1,728 (810) -- 159,883 (160,801) -- ------------------------------------------------------------------------------------ Total revenues ......................... $ 268,028 $ 21,346 $ -- $ 324,470 ($160,801) $ 453,043 ------------------------------------------------------------------------------------ Operating income: Unaffiliated customers .............. $ 225,340 $ 10,943 $ -- $ 139,223 $ -- $ 375,506 Intersegment ........................ 1,728 (980) -- 159,883 (160,631) -- ------------------------------------------------------------------------------------ Total operating income ................. $ 227,068 $ 9,963 $ -- $ 299,106 ($160,631) $ 375,506 ------------------------------------------------------------------------------------ Identifiable assets .................... $2,886,264 $ 2,854,744 $ -- $ 134,957 $ -- $5,875,965 ------------------------------------------------------------------------------------ 1995: Revenues: Unaffiliated customers .............. $ 248,626 $ 13,009 $ -- $ 42,698 $ -- $ 304,333 Intersegment ........................ 1,798 (2,187) -- 40,292 (39,903) -- ------------------------------------------------------------------------------------ Total revenues ......................... $ 250,424 $ 10,822 $ -- $ 82,990 ($ 39,903) $ 304,333 ------------------------------------------------------------------------------------ Operating income: Unaffiliated customers .............. $ 210,799 $ 5,216 $ -- ($ 1,841) $ -- $ 214,174 Intersegment ........................ 1,549 (2,610) -- 40,268 (39,207) -- ------------------------------------------------------------------------------------ Total operating income ................. $ 212,348 $ 2,606 $ -- $ 38,427 ($ 39,207) $ 214,174 ------------------------------------------------------------------------------------ Identifiable assets .................... $2,741,426 $ 2,533,743 $ -- $ 34,110 $ -- $5,309,279 ------------------------------------------------------------------------------------ 1994: Revenues: Unaffiliated customers .............. $ 225,026 $ 16,676 $30,423 ($ 901) $ -- $ 271,224 Intersegment ........................ 4,285 (871) 288 36,110 (39,812) -- ------------------------------------------------------------------------------------ Total revenues ......................... $ 229,311 $ 15,805 $30,711 $ 35,209 ($ 39,812) $ 271,224 ------------------------------------------------------------------------------------ Operating income: Unaffiliated customers .............. $ 189,584 $ 10,571 $ 1,492 ($ 21,728) $ -- $ 179,919 Intersegment ........................ 3,997 (871) 288 36,000 (39,414) -- ------------------------------------------------------------------------------------ Total operating income ................. $ 193,581 $ 9,700 $ 1,780 $ 14,272 ($ 39,414) $ 179,919 ------------------------------------------------------------------------------------ Identifiable assets .................... $2,200,607 $ 2,031,039 $39,132 $ 16,221 $ -- $4,286,999 ------------------------------------------------------------------------------------
48 AMBAC 1996 ANNUAL REPORT NOTE 18 Quarterly Financial Information (unaudited)
First Second Third Fourth Full Year - ------------------------------------------------------------------------------------------------------------------------------------ 1996 Gross premiums written ............................... $50,287 $ 58,115 $67,613 $ 71,193 $ 247,208 Net premiums written ................................. 40,675 48,279 57,800 62,661 209,415 Net premiums earned .................................. 28,193 39,645 33,745 35,046 136,629 Net investment income ................................ 34,827 35,498 36,887 37,729 144,941 Losses and loss adjustment expenses .................. 810 1,700 1,301 (33) 3,778 Financial guarantee operating income ................. 57,210 43,228 56,609 68,293 225,340 Financial services operating income .................. 4,875 2,737 1,133 2,198 10,943 Equity in income of affiliate ........................ 627 -- -- -- 627 Other net realized gains ............................. -- 155,613 -- 700 156,313 Income before income taxes ........................... 57,007 197,777 54,685 66,037 375,506 Net income ........................................... 44,553 135,947 43,828 51,989 276,317 Net income per common share .......................... $ 1.27 $ 3.89 $ 1.26 $ 1.49 $ 7.90 ------------------------------------------------------------------------- 1995 Gross premiums written ............................... $40,196 $ 36,402 $43,531 $ 73,197 $ 193,326 Net premiums written ................................. 36,737 42,916 36,162 48,905 164,720 Net premiums earned .................................. 24,217 27,847 26,233 33,523 111,820 Net investment income ................................ 31,755 32,292 33,192 33,810 131,049 Losses and loss adjustment expenses .................. 1,028 341 841 1,167 3,377 Financial guarantee operating income ................. 43,786 50,094 49,419 67,500 210,799 Financial services operating income (loss) ........... 1,527 (752) 935 3,506 5,216 Equity in income (loss) of affiliate ................. 226 1,867 868 (3,146) (185) Other net realized gains ............................. -- -- 19,103 -- 19,103 Income before income taxes ........................... 40,325 45,779 65,453 62,617 214,174 Net income ........................................... 33,301 36,985 49,485 47,824 167,595 Net income per common share .......................... $ 0.95 $ 1.05 $ 1.41 $ 1.36 $ 4.78 -------------------------------------------------------------------------
Due to changes in the number of shares outstanding, quarterly per share amounts may not add to the totals for the year. 49 AMBAC 1996 ANNUAL REPORT CORPORATE HEADQUARTERS AMBAC Inc. One State Street Plaza New York, New York 10004 212-668-0340 fax 212-509-9190 ANNUAL MEETING OF STOCKHOLDERS The Annual Meeting of Stockholders of AMBAC Inc. will be held on Wednesday, May 14, 1997, at 11:30 a.m. in New York City. Detailed information about the meeting is contained in the Notice of Annual Meeting and Proxy Statement to be sent to each stockholder of record as of March 21, 1997. The Company estimates that it has approximately 18,500 stockholders. FORM 10-K A copy of the Company's 1996 Annual Report on Form 10-K for the year ended December 31, 1996, as filed with the Securities and Exchange Commission, may be obtained without charge by writing to AMBAC Inc., Attn: Investor Relations, One State Street Plaza, New York, New York 10004. TRANSFER AGENT, REGISTRAR AND DIVIDEND PAYING AGENT Citibank, N.A. 111 Wall Street, 5th Floor New York, New York 10005 212-412-6209 STOCK LISTING AMBAC Inc. common stock is listed on the New York Stock Exchange (ticker symbol ABK). The Company is listed in the daily stock tables under "Ambac." COMMON STOCK DATA
1996 1995 -------------------------------------------------------------------------------- Market Price Market Price ----------------------------- ------------------------------ Dividends Dividends Three Months Ended High Low Close Per Share High Low Close Per Share - ----------------------------------------------------------------------------------------------------------- March 31 $49 1/2 $45 1/2 $48 1/8 $0.150 $41 1/8 $36 1/2 $40 5/8 $0.135 June 30 55 1/4 47 1/4 52 1/8 0.150 41 1/2 39 1/4 40 1/8 0.135 September 30 58 3/8 47 55 3/4 0.150 45 39 1/2 44 0.135 December 31 69 1/2 55 3/4 66 3/8 0.165 47 7/8 42 46 7/8 0.150 - ----------------------------------------------------------------------------------------------------------- $0.615 $0.555 - -----------------------------------------------------------------------------------------------------------
INVESTOR RELATIONS 1-800-221-1854 INTERNET: INFO@AMBAC.COM Frank J. Bivona Senior Vice President Chief Financial Officer and Treasurer 212-208-3236 John M. Cathey Vice President 212-208-3490 INDEPENDENT AUDITORS KPMG Peat Marwick LLP New York, New York [LOGO] ABK Listed NYSE The New York Stock Exchange 52 AMBAC 1996 ANNUAL REPORT EX-21.01 10 LIST OF SUBSIDIARIES OF AMBAC INC. EXHIBIT 21.01 LIST OF SUBSIDIARIES OF AMBAC INC. --------------------------------- The following list of significant and other subsidiaries of AMBAC Inc. omits certain subsidiaries which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary. The jurisdiction of incorporation of each subsidiary is included in parentheses after its name. AMBAC INDEMNITY CORPORATION (Wisconsin) AMBAC CAPITAL CORPORATION (Delaware) AMBAC CAPITAL MANAGEMENT, INC. (Delaware) AMBAC FINANCIAL SERVICES HOLDINGS, INC. (Delaware) AMBAC FINANCIAL SERVICES, LIMITED PARTNERSHIP (Delaware) EX-24.01 11 POWER OF ATTORNEY EXHIBIT 24.01 AMBAC INC. POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS that the undersigned director and officer of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 18 day of March, 1997. /s/ Phillip B. Lassiter ------------------------------- Phillip B. Lassiter EX-24.02 12 POWER OF ATTORNEY EXHIBIT 24.02 AMBAC INC. POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said FORM 10-K or amendments thereto, and does hereby grant unto each said attorney- in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 17 day of February, 1997. /s/ Michael A. Callen ------------------------------ Michael A. Callen EX-24.03 13 POWER OF ATTORNEY EXHIBIT 24.03 AMBAC INC. POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said FORM 10-K or amendments thereto, and does hereby grant unto each said attorney- in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 18 day of February, 1997. /s/ Renso L. Caporali ------------------------------ Renso L. Caporali EX-24.04 14 POWER OF ATTORNEY EXHIBIT 24.04 AMBAC INC. POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said FORM 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney- in-fact and agent shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 16 day of February, 1997. /s/ Richard Dulude ------------------------------ Richard Dulude EX-24.05 15 POWER OF ATTORNEY EXHIBIT 24.05 AMBAC INC. POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said FORM 10-K or amendments thereto, and does hereby grant unto each said attorney- in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 18 day of February, 1997. /s/ W. Grant Gregory ------------------------------ W. Grant Gregory EX-24.06 16 POWER OF ATTORNEY EXHIBIT 24.06 AMBAC INC. POWER OF ATTORNEY ----------------- KNOW ALL MEN BY THESE PRESENTS that the undersigned director of AMBAC Inc., a Delaware corporation, hereby constitutes and appoints each of FRANK J. BIVONA and RICHARD B. GROSS, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said FORM 10-K or amendments thereto, and does hereby grant unto each said attorney- in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof. IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 19 day of February, 1997. /s/ C. Roderick O'Neil ------------------------------ C. Roderick O'Neil EX-27 17 FINANCIAL DATA SCHEDULE
7 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 5,088,031 0 0 0 0 0 5,200,542 7,734 0 94,212 5,875,965 60,220 991,224 0 0 223,798 0 0 353 1,614,663 5,875,965 136,629 144,941 135,782 5,261 3,778 37,182 0 375,506 99,189 276,317 0 0 0 276,317 7.90 7.90 0 0 0 0 0 0 0
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